- 1998: Volume 7, No. 5 What's Hot and What's Not

After an early summer lull, all sorts of markets turned "hot" in response to growing economic and financial troubles in Asia, Russia, and now, possibly, Latin America; stocks, bonds and currencies all experienced sharp moves. Other strongly trending markets included energies, livestock, grains and the soy complex.

Hot Markets

Stock Market—Everyone knew that the stock market had to pull back sooner or later so the sharp late August slide in the Dow and S&P wasn't really a surprise. After ignoring Russian and Asian economic turmoil for months, investors finally got nervous enough to liquidate when Russia devalued the ruble. According to the polls, the vast majority of public mutual fund investors look for a recovery and intend to stick with the market. However, even though the long-standing bullish rationale of a sustained U.S. economy with low inflation (there's even deflation in Asia) and low interest rates (many feel the Fed might ease monetary policy by year-end) remains intact, there are probably enough economic concerns to keep a lid on the stock market for a while. Not only are conditions in Russia getting worse (there's talk of total collapse, civil unrest, possible military take-over), but Japan appears incapable of addressing its economic problems. On top of that a currency devaluation by Colombia might be the first domino to fall in Latin America; and troubles there would hurt the U.S. much more than Asia. Since all of that doesn't bode well for corporate earnings, stock prices are likely to keep moving lower.

T-bonds—The bond market broke out the top of a choppy trading range and rallied sharply on safe haven support tied to the sharp decline in the Dow. And due to the weak stock market and growing global economic problems (Latin America might be on the verge of a round of currency devaluations) there are increasing expectations for the Fed to cut interest rates, although the Fed basically said that won't happen unless the U.S. economy slows significantly, which doesn't appear to be in the cards right now. However, as long as global economic problems persist and U.S. stocks stay weak, the bond market should maintain its safe haven bid, making the path of least resistance higher. The only caveats are that a strong rebound in stocks or move toward significant economic reforms in Japan could easily trigger a sharp pullback in bonds. In addition, the recent sharp decline in the U.S. dollar could become a bearish excuse.

Currencies—The dollar rallied sharply in early August in response to increasing global economic problems then suddenly lost its safe haven status and fell sharply on increasing expectations for a U.S. rate cut. As is often the case, it's impossible to guess what rationalizations traders will embrace; and even though a Fed rate cut would leave interest rate differentials solidly in favor of the U.S. versus Japan, and there are increasing signs that Russia is on the verge of total collapse which would threaten Germany, the increased chance of lower U.S. interest rates spooked hedge funds into covering massive short positions in the yen and D-mark. We have a feeling, however, that the dollar will regain its safe haven status once the fund selling is out of the way since the global economy and conditions in Russia are likely to get worse before they get better.

Lean Hogs—Hog prices continued to plunge under the weight of ample supplies and sluggish demand. In addition, the outlook for a slowing global economy doesn't bode well for U.S. pork exports. Combined with huge hog supplies that implies lower prices. Historically, hogs usually bottom in the low area. Pork bellies held up during August due to tight deliverable supplies, but once the spot contract expired, there was nowhere for February bellies to go but down since supplies should be ample by the time that delivery period rolls around.

Live Cattle—This market trended lower, pressured by ample supplies of cattle from heavy placements on feed most of this year. In addition, due to low grain prices, animals have been kept on feed longer than usual resulting in high slaughter weights and even greater beef output. Basically, U.S. consumers just can't eat enough beef and it will no doubt take a cutback in placements and/or a revival of export markets (which isn't likely any time soon) to turn prices around.

Soybeans, Corn and Wheat—The grain and soy markets remained in downtrends due to the outlook for big supplies from big crops and sluggish demand due to the slowing global economy. Only wheat showed some improvement in its supply/ demand balance; U.S. winter wheat acreage is expected to be down 5 to 10 percent this fall and estimates of world wheat carryover stocks have been pared slightly due to flood damage in China. However, the bearish fundamental stories for these markets are likely to stay in place for quite some time. Not only are U.S. crops big, but South American production next season is likely to be huge. Basically, the best chance for a rally comes from fund short covering, and any rebound isn't likely to last for long. Corn prices have reached an area, 200-180, where they historically bottom, however, soybeans still have room to the downside, historically bottoming in the 450-500 range in years of over-supply. Wheat should remain a follower, needing to keep pace with corn in order to price itself as a feed grain due to the dismal export outlook.

Natural Gas—It's getting to that time of year when a natural gas trader's fancy turns to thoughts of winter peak demand, which usually results in higher prices. This market has fallen sharply over the past month due to rising storage stocks and a return to normal summer temps, reducing air conditioning and power generation needs. However, even though supplies are at a record high level, concern of a colder than normal winter across the northern U.S. in the wake of El Niño is likely to trigger a rally at some point. In addition, in 1997 and 1998 the funds were big buyers starting around this time of year. In fact, last fall they produced a sharp rally even though the fundamental story was arguably bearish; a warmer than normal winter was expected due to El Niño; and supplies were adequate. Obviously, should temperatures remain benign, higher prices won't be sustained, but there are always several outbreaks of Arctic cold each winter so we'd expect some upward price spikes.

Markets That Could Get Hot

Crude Oil—This market has been in a sustained downtrend but jumped moderately higher recently implying that oil producers might finally have cut output enough (they've been cutting back since April) to put a floor under prices. Although global stockpiles are burdensome, there's the potential for a short covering rebound. In addition, due to Iraq's belligerent stance toward the U.S. and U.N., and the rising wave of terrorism, there's always the chance for a flare-up of Midwest tensions. However, at this point, a sustained uptrend in the energy complex doesn't appear likely.

Heating Oil—Like natural gas, it's the time of year when traders begin anticipating peak winter heating oil demand which usually results in a rally to establish a "weather premium." However, even though the odds of a colder than normal winter across North America might have been increased by the demise of El Niño, we doubt there will be much of a rebound this year since supplies are so large, leaving a big cushion in the case of frigid temperatures.