A trend that belies the desperation among many market participants for tech and financials to lead resurfaced Thursday: The stock market can't get a good rally going unless commodity-related stocks are firing on all cylinders.
After Wednesday's cyclicals-led rally, major stock market indices dropped Thursday amid weak performance by the energy, materials and industrials sectors. The
Dow Jones Industrial Average
fell 0.54% to 11,019.11, while the
dropped 0.53% to 1245.60, and the
declined 0.85% to 2122.98, weighed down by nontech components, such as
The Morgan Stanley Cyclical Index fell 0.5% Thursday, while economically sensitive names like
put in a relatively poor showing Thursday after strong gains on Wednesday. Caterpillar fell 0.65% and DuPont fell 0.43%.
On the flip side, nickel mining company
posted strong profits and raised its earnings guidance. The company's stock gained 1.2%.
Meanwhile, U.S. Treasury yields rose, approaching the expected rise in the fed funds rate to 5.25%. The FOMC meeting ends next Thursday, and the central bank is expected to hike the funds rate for the 17th straight time. The two-year note fell 2/32 to yield 5.23%, while the 10-year ended down 12/32 to yield 5.20%.
A glut of liquidity had driven investors to risky assets around the world, including leveraged bets on commodities. That liquidity is being drained as global central banks tighten monetary policy. The result has been many markets moving lower in correlation amid the risk-reduction trades.
But while the energy, materials and industrials' market leadership won't last forever, commodities are not dead -- contrary to some reports and a view the leadership is shifting to big-caps, or tech or financials. The underlying commodities markets themselves are more likely in a long-term bull market, says Mary Ann Bartels, chief U.S. market analyst at Merrill Lynch.
Speculation and leveraged bets are causing a correction in some commodities -- particularly those traded in exchange-traded funds and mutual funds like the precious metals. The Philadelphia Gold and Silver Index declined 0.9% Thursday, while the price of gold dropped 0.19% and silver fell 0.24%. The price of copper declined 0.34% Thursday. Those metals had gained Wednesday as the stock market rallied.
Other commodities are not as volatile. A correction in the more speculative commodities may be due, but that shouldn't cloud the rest of the commodities complex, which includes agricultural commodities, burlap, certain chemicals, iron, zinc, and even orange juice, for example.
"Not all commodities are pigs," says Bartels. "Lean hogs just broke out."
From a technical perspective, every element of the commodities complex has broken through 20-year trading ranges this year, she adds. That makes for a broad base of stability that can allow commodities to sustain a rally for the next three to five years, Bartels says. The last time this happened was in the 1970s when commodities broke through 16-year trading ranges and stayed in an overall bull market for 10 years.
has made a point to mention energy and "other" commodities and is paying attention to how they impact the economy, says Howard Simons, strategist at Bianco Research and a
contributor. The Fed isn't referring to hedge fund phenomena, he says.
The fundamental reason for a bull market in commodities is the global growth story. Demand for commodities will remain robust because China has 1.4 billion people, and the nation is growing at 9% a year. That says nothing of India and countries in Latin America growing at a rapid clip.
"Did we get ahead of ourselves two months ago? Yes," says Simons. But "until and unless we see a major breakdown in Chinese growth or Indian growth, we have to consider this a long-term bull market."
Part of why commodities move in such volatile V-patterns is because they are traded in the futures market, notes Bartels. This means that as long as the commodity keeps rising in price, the traders post a gain, which can be used for further margin, or borrowing to add to the position. The process that evolves is called "pyramiding." The danger is that when the price turns down, the investors get margin calls, which they don't want to pay, so they dump their investments, and the market declines dramatically.
Bartels believes that the commodities-related stocks in the energy, materials and industrials sectors will be the market leadership as long as the commodities themselves rally. Indeed, the market may be witnessing a buying opportunity at the end of this commodities correction.
But the commodities-related stocks and commodities themselves don't always move together, says Simons. Indeed, the stocks usually rise ahead of the actual commodities. For these economically sensitive companies, their costs rise as rapidly as their revenues. So, as demand for zinc grows, for example, the company mining that metal has to spend to meet the demand and spend without much of a lead time on its supply needs. So, the cost of the input materials will rise as much as the demand for their product rises. That company is investing only when everyone else is investing in it, says Simons. As a result, these stocks can lose their leadership while the commodities remain in a bull market.
Risks to the commodities bull market include the possibility of a crisis in China. "Emerging markets crash," says Simons. "It is what they do. Something can't grow at 9% a year without building up a stress somewhere." The U.S. in the 1900s was an emerging market that crashed every 20 years, he notes.
While it is hard to argue with the growth story in the East, China is not a free-market economy. Its banking system is in disarray, and a culture of mis- and disinformation is still at work, says Simons. "It is easy to have a strong growth story if you don't pay your bills."
In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click
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