Will September Rain on the Bulls Parade?
Let's start by having a look at the commodity-based stocks. Earlier this week we talked about the latest findings in the oil sector. Huge new oil fields discovered in Venezuela and Mexico are all the talk from a political standpoint and will have to be factored into the current oil market as more information becomes available, not so much with regard to supply as with regard to near-term availability.
Meanwhile industry consolidation continues at a steady pace in both the oil/gas exploration and gold/silver mining sectors. It has long been my contention that one of the major reasons for long-term bull markets being engineered is to allow the sectors or industries in question the economics to leverage buyouts, mergers and acquisitions. This has always been true of the great bull markets of the past 150 years, to wit, greater consolidation within an industry. We've certainly seen this transpire in recent years with a greater number of mergers within both industries as the bigger companies gobble up the smaller ones and shrink the field of competitors.
Earlier this year we saw Barrick Gold take over Placer Dome in a $10.4 billion deal. Later we saw Glamis Gold buy Western Silver. More recently, Goldcorp made a bid for Glamis for $8.6 billion in stock. Analysts are now predicting Newmont will start buying up assets in order to maintain its leadership position among the golds. As the Financial Times recently observed, many within the industry now believe the South African gold group AngloGold Ashanti will be the next big potential acquirer since its ties to its parent company Anglo American have been severed. The game of industry consolidation is accelerating in the precious metals mining sector as the huge bull market gains of recent years makes it easier to achieve economies of scale among the industry players.
But the flip side of record corporate earnings and M&A activity is that it tends to evoke its own reversal at extremes within the trend. In other words, a huge increase in industry mergers and acquisitions usually precedes at least short-to-intermediate-term tops within the stock market industries question or at least a temporary halt to the upward progress of stock prices within these industries. That has certainly been true this year for the gold mining stocks and, to a lesser extent, the oil/gas stocks.
Futures magazine showed a picture of the U.S. dollar shrinking in size on the front cover of its September issue, accompanied by the headline: "The Incredible Shrinking Dollar?" and asked "How low can the U.S. dollar go?" Within days the price of gold as measured in dollars fell sharply on Monday, Sept. 11, to a multi-week low of $588/oz. A couple of things are worth mentioning as being the culprit in the decline, the first being a monster rise in the 10-month rate of change oscillator. I've used the 10-month ROC for the gold price for the past few years and it has always been banded within a trading range with the "overbought" ceiling of this range at about 60-65 and the "oversold" floor of the range between zero and 24. But earlier this year the gold price oscillator broke out above its multi-year trading range high of approximately 65 and soared all the way to above 200! That put the gold price at its most overbought reading in years (from a longer-term standpoint). That's why the latest gold price decline should go a long way toward working off this excess froth.
One possible explanation for the recent commodities price slide, aside from technical considerations, is provided courtesy of the Financial Times in a September 1 article titled "China to push for lower prices of commodities." The Times noted that "China's prevalent, short-term, trading mentality, combined with its inexperience in managing long-term contracts, has resulted in many of its companies relying on the spot market for resources," adding that this strategy has been "disastrously expensive" for China. The article stated that China will now "demand a larger role in setting global commodities prices" with its announcement that it will "form new industry negotiating groups to leverage its buying power to secure lower prices." There can be no disputing that China and other industrial countries benefit when commodity prices pull back, even if only temporarily.
With respect to the stock market outlook in September I believe it's a case of good news/bad news. Here's the potentially bad news: The market doesn't appear ready to blast off to the upside any time soon. This may have to wait until October or November despite the 8-year cycle being out of the way. The main reason for this lingering weakness (or perhaps a better description would be simply a lack of vibrant energy) is the monetary liquidity situation. Other than looking at daily securities lending volume, I rarely mention money supply/demand as measured by the monetary aggregates and the yield curve as having a major bearing on the stock market. But this is one of those instances when it does, a la' 2001. You may remember the recession of that year, which while short-lived was rather deep in some areas of the economy. It also had a major impact (mostly negative) on the stock market since the necessary liquidity simply wasn't there to push the market higher.
The yield curve has been negative now for a few weeks while the Dow Transportation Average has been down and both of these signals taken together *could* be pointing to a mini-recession ahead. (I doubt such a recession this time would be as bad as the one in 2001, however.) But until the monetary liquidity starts dramatically increasing it's really hard to see a major sustained bull market in stocks since this is required to kick-start any worthwhile bull market. Another potential negative, short-term, is downside potential later in the second half of this month (seasonally and historically a weak period) but should be limited to the June or July lows in most of the major indices. Potentially a lower low could be made in the small cap indices such as the Russell 2000 (RUT) and S&P 400 Midcap (MID).
Now here's the potentially good news: There should be an overall trading range environment as opposed to an outright downtrend, particularly in the large cap indices and possibly the gold/silver and oil stocks. In this type of environment the overbought/oversold oscillators will be invaluable for spotting buy/sell signals for short-term trading. There could even be a slight upward bias to the anticipated trading range in the Dow and S&P. A crash or serious decline in the major large cap indices isn't likely since there are a number of psychology-based indicators that show enough support from a contrarian standpoint (including the Rydex Ratio). Also, the negative and fear-laden headlines the media keep throwing out at the public is preventing the public from growing excessively optimistic or euphoric, something that's a major ingredient in a stock market crash. Without it, the market is more likely to continue its broad trading range movement in the coming weeks. (The Washington Post featured an article in its Friday, September 1, edition entitled "Creature From Black Monday...Alive" The article was about the market crash of 1987 and discussed the possibility of it happening again based on computerized trading programs. This is the type of worry that I'm referring to that is helpful in building a "Wall of Worry" support under the market to prevent a crash.)
That about puts it in perspective for the first half of September but what about the second half of the month? There's an old Wall Street saying: "September is when leaves and stocks tend to fall, on Wall Street it's the worst month of all." This adage applies mainly to the second half of the month.
According to Stock Trader's Almanac, September tends to be the biggest percentage loser for the S&P, Dow and NASDAQ. As STA points out, September opened strong in nine of the last 10 years, including last September, but the month tends to close weak due to end-of-quarter mutual fund portfolio restructuring. STA also points out that September's Triple-Witching Week is "dangerous," with the week following described as "pitiful." This September's options expiration falls on Friday the 15th, which is also the deadline for quarterly tax filings. So we'll need to be on the lookout for a potential short-term market top later next week.
In years when the 4-year and/or 8-year cycle bottoms, which includes this year, the cycle most often bottoms on or around September 1. In the previous 4-year cycle bottoms here is how the market as measured by the S&P 500 index performed for the month of September:
1994: 4-year cycle bottoms with 10-year cycle; September sideways-to-slightly-higher in first half of month, bearish in second half. Ends month with a loss.
1998: 4-year cycle bottoms with 8-year cycle at start of month; September ends with slight gain.
2002: 4-year cycle bottoms with 12-year cycle; September sees sideways S&P in first half of month followed by decline in second half, mainly due to influence of 12-year cycle. Ends with net loss for the month.
2006: 4-year cycle bottoms with 8-year cycle; so far S&P shows slight downward bias but still well above the August lows. Will the market rally to the recent highs next week? If so, will the second half of the month show the downward bias that normally accompanies the second half of September? Time will tell...