June 24th, 2008

What We Fear Most

This morning, Congress is starting their hearing on the impact of speculators on oil prices. It’s a precursor to action that members feel they need to take for political purposes. I say political since unilateral action by Congress to try to impact an internationally traded commodity could have effects about as damaging as Nixon’s attempt with price controls in the ’70’s. For those who weren’t around then and those who don’t remember, it was investigations (then by the SEC) that contributed to the selling stampede that triggered the October, 1987 crash. As I write in my book, “Running with the Herd”:

“…since the SEC was unable to prevent shady IPOs and conglomerates from proliferating, in early 1987, it begun conducting numerous investigations of illegal insider trading. The SEC, however, could take investors to the proper information about the risk in these IPO’s, it couldn’t cause them to change their behavior. Even though the SEC required companies to state explicitly that they had no assets or even a fighting chance at getting any, investors still believed that the potential for the companies was limitless. The barrage of SEC investigations finally began to rattle investors. By October, investors decided to move out of the crooked game and into the more stable environment offered by bonds or, in some cases, junk bonds.”

Yes, it was computer program trading and the inability of the NYSE to handle the influx of orders that actually caused the 20.47% one day drop on Monday, October 19, 1987 (on top of 8 of 9 previous days adding contributing another 14.6% to the total meltdown). But it may have been SEC investigations (read Congressional) into shaddy IPO’s (read O&G speculation) that actually served as the pin that pricked the bubble.

It’s not higher interest rates or political change or the value of the $US — it’s the bursting of the commodity and, especially, the oil bubble that we fear most. Not only because we own so many positions in our portfolio but also because if those stocks crash theirs nothing left to support the market. With financial stocks on their backs, it’s been the oil & gas sector that’s what’s supported the market averages. I know we don’t actually invest in the Indexes (unless we own an Index fund or SPY etf’s), but if the market indexes drop it will by virtue of market momentum bring the rest of the stocks down too.

Here are a couple of charts using industry etf’s as a proxy to underscore the extent to which Oil & Gas has helped sustain the market even to the extent that it has:

  • OIL (S&P Crude Oil Tracking ETF): 172% increase since January 17, 2007

  • XES (SPDR O&G Equip & Svces ETF): 100% increase since October, 2006; note unfavorable volume trends since beginning of year

  • XOP (SPDR O&G Exploration & Production ETF) 106% increased since October, 2006

Even though I wrote yesterday that one shouldn’t fight the tape, the whole Oil & Gas sector seems greatly extended by most technical measures (for example, Bollinger Bands). I started closing out some positions today. Selling too early? I won’t know for a while but the Congressional Hearings are my “tell” that it’s time to lighten up. It also may be impetus for the S&P 500 to resume its decline to 1150 and, perhaps, beyond.

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