Small caps bounce as commodities fall

Kevin Pendley | Aug 05, 2008 10:10am EDT | Comment

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Small-cap stocks pushed higher in early trading, bolstered by sinking crude oil and other commodities, which helped ease inflation jitters. At 10:02 a.m. ET, the Russell 2000 (NYSE:IWM) was up 10.39, or 1.48% at 714.53, gaining back a sizable chunk of Monday’s losses, but holding within the recent trading ranges.

The ISM non-manufacturing survey came in at 49.5%, which was above the forecast of 48.5%, but still slightly below the 50.0% level, which denotes expansion vs. contraction in the services sector. The market remained on firm footing through the ISM data.

Now that ISM is out of the way, many investors will wait for this afternoon’s FOMC announcement. Although the Fed is not expected to shift short-term rates on Fed funds, the language in the statement could spark some movement in equities, interest rates and foreign exchange. There is some thought that the recent decline in crude oil prices will provide the Fed a little breathing room on the inflation fighting front, and lessen the need to act prematurely to stave off rising prices via tighter monetary policy.

Crude oil prices went into a tailspin Monday and continued to retreat this morning, pulling back near the $120 line into the U.S. stock market open. Crude oil prices are now about 18% below the record high set a few weeks ago, which should provide relief to businesses that have seen margins sliced away by soaring fuel costs. The poster child for that argument has been the airline industry. The AMEX Airline Index was up 4.4% shortly after the opening, and is up 82% since bottoming out July 15. Small-cap airline US Airways Group Inc. (NYSE:LCC) was up about 8% in early trading. Another benefactor of a drop in gasoline pump prices would be consumers, and investors hope those dollars flow into retailer pockets instead of being drained at the gas station.

Crude oil is just the headline act of a very big story that is unfolding in commodities of late. The iPath GSCI commodities index fund has collapsed nearly 17% since July 11, and is now at 3-month lows. Gold prices have tumbled to 6-week lows, platinum is at 6-month lows, soybeans are at 3-month lows, cocoa prices were hammered Monday, and there is plenty of speculation that a global “bubble” in commodities has been burst, and that massive hedge fund unwinding of long commodity/short dollar and short equity trades is taking place.

The dollar is clearly on a roll, climbing to 7-week highs this morning while jumping nearly 100 basis points against the euro. A strong dollar will suggest to many that overseas investors are moving into U.S. equities, and will also reflect relative strength in the U.S. economy vs. other world markets.

Broad market sectors in rally mode this morning included office supplies, tires and rubber, employment services, hotels, insurance firms and department stores. On the downside, gold, brewers, coal, gas utilities and oil drillers were getting drilled.

Individual small-caps on the move were highlighted by Castlepoint Holdings Ltd. (Nasdaq:CPHL), which was up 27% on news that the firm will be acquired by Tower Group for $490 million. Blackbaud Inc. (Nasdaq:BLKB) jumped 17% on earnings news. Emergency Medical Services Corp. (NYSE:EMS) was up about 12% as quarterly results topped the forecast. On the downside, Rackable Systems Inc. (Nasdaq:RACK) was down 15% on sloppy earnings.

Looking at the chart picture here for the Russell, the market remains trapped in a range between 694.50 on the downside and 726.20 on the upside. A breakout in either direction of that congestion zone would carry a target move of 32 handles and is the most important thing to watch through this week’s trading action. In addition, the Russell is holding below trendline resistance drawn off the June peak and also from the mid-July highs. One could argue that a bullish flag pattern has formed off the recent lows, but that pattern will need a breakout resolution soon. For short-term trading, look for resistance today at 714.50, then at 720. Support should come in at 701.