Good news, bad news

9/8/2008


Investors seem increasingly concerned that the sharp decline in commodity prices may portend a more protracted global economic slowdown, which would not be good news for stocks. Still, with both the Dow Industrials and Transports trading above their July lows, the market’s primary trend remains bullish, according to the Dow Theory. For now, subscribers are advised to hold 15% to 20% of equity portfolios in cash or short-term investments. 

The bearish side of cheaper commodities
Consumers and investors have welcomed the steep decline in commodity prices for several reasons.

Declining prices, particularly for oil, have given consumers some financial relief. If prices continue to fall, consumer-spending trends could improve later this year.

The drop in commodity prices should reduce inflation, which has become a larger concern on Wall Street in recent months.

Good news on inflation has given the Federal Reserve Board more latitude in keeping interest rates low.

However, there is a potential dark side to the decline in commodity prices that seems to be gaining momentum. If the stock market believes the sharp drop in commodity prices foreshadows a major decline in the global economy — and recent poor market action lends some credence to this notion — than investors could witness something they have not seen this year: falling commodity prices and falling stock prices.

To be sure, one barometer of future economic activity — the Dow Jones Transportation Average — remains nearly 9% above its July low of 4,653.13, so talk of a global recession may be a bit premature.

But if the economically sensitive Dow Transports close below their July lows, and if the Dow Industrials track a similar path and close below their July lows of 10,962.54, the prospects for a global recession would increase.

At this juncture, the market will be hard pressed to sustain any rallies without new leadership emerging. Technology stocks could fill that role, which is why it pays to watch the action of the technology-heavy Nasdaq Composite Index. A strong move above the Aug. 14 close of 2,453.67 would be bullish for tech stocks and have positive implications for the broader market.

Conclusion
The Forecasts remains comfortable with its 15% to 20% cash allocation for equity portfolios. For investors who want to take advantage of recent market weakness, Qualcomm ($51; NASDAQ: QCOM) has come off its highs in recent days and offers an attractive buying opportunity.


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