The overall market as measured by the Dow Jones Industrial Average finally turned higher with last Wednesday's trading activity with the Industrials closing higher by over 250 in the next two (2) trading days. The rest of the market followed the Industrial's lead and we had a little rally take hold. The rally was somewhat sparked by some positive comments during congressional testimony, and some better than expected earnings results in the financials. There is a good chance the Industrial could rally another 250 points or so to our next upside target of 11,740.15, but then I get somewhat skeptical about it continuing much beyond that. I think what we are experiencing right now is probably a short term rally from an oversold position.
I think there are several long term factors that are weighing on the market, and the uncertainty over these issues is putting downward pressure on the market. I think the market will continue to be under pressure until there is clarity on these issues. I see at least five serious issues facing the market and economy. I think these issues will need to be addressed before the market can stabilize and eventually move higher.
1. Political Uncertainty. Politics is the single biggest influence on the market. The political situation in Washington influences all most everything else in our lives and the market. I think there is a great deal of uncertainty over the election in November, and what is going to happen afterwards. This will probably weigh on the market until November.
2. Financial System Weakness. The weakness in our financial system and the major players in the financial system is not good for our overall economy. The fact that these companies are facing a Pandora's Box of losses for the foreseeable future doesn't help and it generally serves to destroy the confidence people have that these companies will be able to survive. The fact is that no one really knows how long it will be before Merrill Lynch, Citigroup, and the other players in the mortgage arena can finally return to profitability or if they will be forced out of business. I think the best we can do is to figure there earnings are going to be tied to the housing sector, and when the housing sector finally goes through its shakeout from all the financially weak buyers being forced out of their houses then we will see the housing market stabilize and these financial firms return to profitability.
3. Taxes. The expiration of the Bush tax cuts is going to cause one of the largest percentage tax increases in the post war economy. Raising tax rates will slow down the economy, it will hurt the earnings of our public companies and depress the stock market. Since tax levels are a function of politics, this issue will probably continue to weigh on the market until the election in November.
4. Oil Prices. The high price of oil continues to be a problem for the country and the economy. You can say what you want about energy being a smaller portion of the economy than it was in the 1970's, but the fact of the matter is that the higher cost of energy is going to result in lower spending somewhere else or at the very least lower savings. Come this winter, this is really going to be an issue for everyone in the country. Home heating oil is 50% higher than it was a year ago. That portion of middle America that lives in the Northeast is going to be in for some real pain in 6-8 months.
5. Dollar Weakness. I could write a book on this topic. The weakness in the dollar is putting upward pressure on the price of oil, and other commodity products. The weakness in the dollar is somewhat caused by a the high price of oil, low interest rates, and the expectation of rising tax rates. Strength will return to the Dollar by raising interest rates, lowering taxes, and a return of confidence for the strength of our financial system.
I will be taking a more in depth look at these topics in the upcoming additions of the Sterling Weekly. If you are not a subscriber, please be sure to sign up in order to see our upcoming comments.