Russell sinks amid record oil, jobs data

Kevin Pendley | Jul 03, 2008 1:53pm EDT | Comment

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Small-cap stocks edged lower Thursday, unable to match gains registered in large-cap indices as the specter of record high oil prices and high unemployment were enough to hold back the Russell 2000 (NYSE:IWM). The Russell closed down 6.56, or 0.98%, at 665.78, the lowest daily close since March 19.

Despite the negative finish, the market did mount a modest solid bounce off the morning lows, finding support above 660, which is the next big test for an index that is once again back in bear market territory and flirting with a hard retest of the March trough.

Even though there seemed to be a little disconnect between the news and price action today, some traders weren’t that surprised with the overall trends. “I think a portion of Wednesday’s sell-off was linked to jitters over the employment report. The market was bracing for a payroll number closer to minus 100,000,” Nick Kalivas, vice president of financial research with MF Global, said in an email interview.

Also, Kalivas said that the weak performance in small caps compared to the Dow and S&P 500 was tied to a wave of profit-taking in small-cap energy shares, which were up sharply in the second quarter.

In some ways, price action today was relatively unsettling as headline figures on monthly employment and a rate hike by the ECB would seem to be bearish, but were embraced as far better than the “whisper” numbers bandied about in a worst-case scenario. In the case of employment data, the headline figure came out at minus 62,000, which was relatively close to the median forecast for a loss of 60,000. However, when the ADP report came out Wednesday at minus 79,000, it prompted some talk that the Labor Department figure could be closer to minus 100,000, which meant that losing “only” 62,000 non-farm jobs suddenly didn’t seem all that bad. It’s a little more tricky to shrug off the 5.5% unemployment rate however, which analysts expected to dip to 5.4% or even better after last month’s dramatic 0.5% leap was supposedly a statistical quirk. Regardless, the market chose to take the “glass half full” approach to the report.

“The unemployment rate stayed higher in June after soaring in May. This suggests that May’s surge in joblessness was more of a catch-up to the slow rise in the prior six months than a seasonal adjustment difficulty. Regardless, over the past year the number of unemployed has increased by 1.5 million to 8.5 million and the unemployment rate has increased by one percentage point to 5.5%. In the post-World War II period, every time the unemployment rate has jumped by a full percentage point in the course of a year, the economy has slipped into recession,” Steven Wood, chief economist with Insight Economics, said in an email.

As for the ECB rate hike, there was some concern that the central bank would take a bold stand and raise rates 50 bps, so a 25-bp move also didn’t meet the worst-case scenario. And comments from ECB president Jean-Claude Trichet seemed to suggest that the ECB isn’t on the warpath yet against inflation.
“At the margin, Trichet’s neutral bias has been helpful to the stock market. The Eurozone fixed income markets were pricing in another rate hike and his comments eased rate hike fears,” Kalivas said. “Stocks were worried about tighter monetary policy, high raw material costs and slower growth. Tighter policy seems less likely and takes some pressure off the Fed to hike rates,” he said. What’s more, the dollar made a dramatic rally after the news, soaring over 1.1% against the euro, which supported equities as well.

Curiously, the surge in the greenback didn’t appear to have that much of an impact on energy markets. Crude oil prices did pull back off record highs met earlier in the day above $145 dollars a barrel, but still were on track for a record high weekly close. Heating oil and gasoline also notched record highs today as well. Speaking of energy markets, Congress this week approved legislation directing the Commodity Futures Trading Commission to “curb immediately” excessive speculation in energy futures markets. There was talk circulating that the CFTC would dramatically raise margin requirements to try and squeeze out speculators. If that happens, according to some market watchers, it could be a troubling case of regulators bowing to a truly silly witch hunt for a scapegoat. Consider this: energy futures are at record highs. That means the longs have been making all the money. If you raise capital requirements for margins, you will put even more pressure on the shorts to get out. You could actually see crude oil futures rise without fundamental cause because legislators are artificially putting more pressure on those trying to sell crude oil.

Back to the economic data front, the ISM Non-Manufacturing Survey came out at 10:00 a.m. ET, with the headline number at 48.2, which was well below the median forecast. In addition, the prices paid index was the highest since the data began in 1997. When the ISM report first came out, equity index products coughed up the opening rally, but the ISM report seemingly had little staying power as the day progressed. Looking at next week’s calendar, things will be very quiet, without any truly “big” economic reports on tap.

“I think the market is oversold in front of a long weekend. Short covering is occurring and there may be some bottom fishing against the March lows in the S&P 500. The outlook for a bottom has improved, but the middle of next week makes more sense to me. Financial shares have stopped going down after leading the market lower. A large dose of the negative news has already been priced into the market. The rest of the market is catching up to the financials and the sell-off in momentum driven small-cap energy stocks is an example of this. I’d like to see volatility surge and small-caps move closer to their March lows before playing for a lasting bottom,” Kalivas said.

Although the Dow and S&P 500 held up well today, tech stocks were a little less robust. Broad market sectors on the decline Thursday were highlighted by managed health-care, thrifts and mortgage financial firms, agriculture products, home furnishings and gas utilities. Despite the rise in energy prices, oil exploration, and production, refining and marketing drillers and storage stocks were all in negative territory today. On the upside, industrial gases, paper, chemicals, tires and rubber, food retail and household appliance stocks were higher.

Small caps of note today included Acme Packet Inc. (Nasdaq:APKT), which tumbled 39%, gapping lower when the firm updated its outlook and investors weren’t impressed with the revision. TranS1 Inc. (Nasdaq:TSON) tumbled 28% on a revenue pre-announcement and ARYx Therapeutics Inc. (Nasdaq:ARYX) shed nearly 20% on news that Proctor & Gamble exercised an out clause to stop a collaborative trial on a constipation drug. Bucking the overall downdraft, DemandTec Inc. (Nasdaq:DMAN) rallied about 23% on strong earnings. Evercore Partners (NYSE:EVR) was up 10%, finding support after sinking relentlessly for the past year and making new lows Wednesday.