11, 2008 -- Last spring, I warned that the, "housing mess" and sub prime problems had the potential to wreck the Dow Jones but send bond prices higher as investors sought safety and avoided risk. I even went so far as to suggest exiting stock portfolios and replacing them with a bond portfolio. But stocks continued to rally and bonds remained lethargic into the early fall as my timing on that outlook was faulty.
In September, however, I became so concerned those problems would wreck havoc with the US economy that I boldly stated, "stocks and commodities had little room left to run to the upside." Both markets would soon decline substantially. "Sell stocks and commodities" was my suggestion. Since the fall, the Dow Jones has dropped 11 percent from its high while bond prices have rallied at least that much and are off to their best start for any year since 2001. But commodities such as grains, metals, the energy markets and the widely followed CRB index have continued upward in a frenzy of bullish enthusiasm. My predictions for stocks and bonds was very accurate but for commodities not so accurate.
Stocks and bonds are moving opposite because the markets fear the US is already in a recession or about to endure one. The "r" word is being heard everywhere!
The Economist, under the headline "Recession Talk is Rising" stated, "The Economist's informal R-word index is also sounding alarms. Our gauge counts how many stories in the Washington Post and the New York Times use the word "recession" in a quarter. This simple formula pinpointed the start of recession in 1981 and 1990 and 2001. In the past few years the R-word index has been extremely low. It began to rise in the second half of 2007 and, measured at a quarterly rate, has soared in early 2008. Although the number of stories is still lower than before previous recessions, the recent jump, if sustained for a quarter, is similar to that which preceded the 2001 downturn."
Look closely at how the Dow has been performing: the first five days of the New Year were the worst since the 1930's; the first two full weeks of the New Year was the worst start since 1982;
The Chicago Tribune said, "Historic market patterns indicate that if the results of the first five trading days of the new year are positive, the market is almost always up for the year, according to the Stock Trader's Almanac. When the first five days end in a loss, chances of a positive year diminish to about 50 percent."
The only markets that are red hot bullish now, other than bonds, are commodities. But can commodities continue to rise with the Dow in trouble and the perception the economy is slipping into a recession? When it comes to the commodity markets, "the stick that stirs the drink" is crude oil. This week, crude values fell 5.3 percent out of fears a global (yes global) slowdown will cut consumption and force prices lower. Since the futures market has an excellent record of forecasting the future, here is how the crude oil market ended this week; The highest prices are the front months, Feb. and March with an average value of $92.46 a barrel. Gazing out to Dec. '08, prices are less than $89 while Dec. '12 thru Dec. '16 prices are less than $86 a barrel. The futures market, looking out 8 years from now is hinting that the "r" word will, for the time being, keep crude oil prices in check. Recessions tend to do just that!
To understand how red hot the commodity markets are consider these tidbits. Some firms are pushing investors and traders to buy "call" options for $200 a barrel crude oil while a large German bank is forecasting soybean prices to exceed $21 a bushel in late '08. In light of problems plaguing the economy such forecasts are classic examples of irrational exuberance and hint a top in commodities is near.
The duration of the current downturn with the Dow and the US economy is unknown. In face such a scenario, it is always better to be safe than sorry. My advice this week is not much different than what I offered in September. I would rather own bonds than stocks. And if crude prices sink out of fears of economic weakness, many other commodity markets are also living on borrowed time.
Grain producers should be selling at least 50 percent of projected '08 corn and soybean production right now. Cattle producers on the other hand should be lifting or buying back hedges placed at higher levels as soon as possible. Hog producers should be ready to follow the lead of cattle producers in the near future.
If I can be of help, feel free to call me at 406-682-5010. I have some ideas that you may find interesting.
(The information in this article is the opinion of Commodity Insight's Jerry Welch and subject to change without notice.)