Modest rise despite crude recovery

Kevin Pendley | Jul 10, 2008 5:04pm EDT | Comment

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Small-cap stocks weathered several storms today to punch out a higher close as investors were able to look past a sudden reversal higher in crude oil futures, renewed credit crunch worries amid a collapse in mortgage finance stocks and safe-haven money flow into short-dated treasury products. Oversold conditions and bargain hunting spurred by merger activity were enough to pull small-cap stocks into the green. The Russell 2000 (NYSE:IWM) rose 6.68, or 1.01%, to 670.44.

Heading through midday trading, the market tried to carve out a modest recovery rally in the wake of Wednesday’s big collapse, but a sudden afternoon surge in crude oil prices stomped out bullish sentiment in equities — at least for a while. Crude oil prices charged more than $5 a barrel higher, climbing back above $141 on supply concerns out of Africa and Brazil and amid ongoing tension in the Middle East.

Workers in Brazil threatened to initiate a five-day strike next week, while a ceasefire in Nigeria threatened supply from Africa. Meanwhile, Iran said it has been test-firing more missiles, as a “lesson for enemies;” U.S. officials warned Iran that it would defend its allies. The potential for supply disruption and geopolitical tension was enough to spark the sudden resurgence in crude oil prices, which had tumbled some $10 a barrel off recent record highs.

S&P 500 futures actually made their daily high this morning before the regular market even opened, rising to highs in conjunction with a better-than-expected headline figure on the weekly jobless claims report. The report showed a decline in claims to 346,000 which was much better than the 395,000 forecast and a big improvement on last week’s 404,000 figure. However, there were some “devils in the details” of the data, which hinted that all is not well in the labor market.

“Continuing claims, which lag initial claims by one week, rose 91,000 to 3.202 million. The insured unemployment rate moved up to 2.4% from 2.3% in the prior week. The insured unemployment rate has held at 2.4% in three out of the last five weeks. The noticeable decline in initial claims is a distortion and is not an indicator of a market improvement in labor market conditions,” Asha Bangalore, economist with Northern Trust, said in an email.

She also said the sharp drop in weekly claims was a reflection of the short week due to the July 4th holiday and was exaggerated by distortions arising from auto retool shutdowns in the summer. “Moreover, economic data of the past six months suggests that firms have stopped hiring and robust demand for labor is unlikely to emerge at this stage of the business cycle. In addition, the labor department has indicated that a sharp jump in jobless claims, to account for the auto industry shutdowns, is likely to follow soon,” Bangalore said.

The fact that the market was able to close higher at all was a healthy sign, especially given sharp losses in Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE), which lost 14% and 22%, respectively, following comments from former Federal Reserve official William Poole that the firms could face insolvency.

As tension mounted in the morning over the plight of mortgage finance giants, investors rushed into the Treasury market to snatch up short-term debt instruments as a hedge against calamity that might stem from the credit crisis. As a result, the yield on the T-bill tumbled to its largest one-day rout in several months. One might expect all financial stocks to cower under yet another storm cloud, but the results were mixed. Lehman Bros. (NYSE:LEH) clearly found another round of sellers as the brokerage firm tumbled 12%. In addition, Wachovia Corp. (NYSE:WB) shed 8% as the firm announced new leadership and analysts downgraded the stock.

In addition, key consumer staple Wal-Mart (NYSE:WMT) reported same-store sales jumped 5.8% during June, which topped the forecast for a rise of 3.8%. Although Wal-Mart’s stock rallied in overnight trade, it couldn’t gain traction in the regular session today and ended down 0.8%. There was some thought that the bump in Wal-Mart’s June sales may have been bolstered artificially by fiscal stimulus checks.

On the M&A front, news that Dow Chemical (NYSE:DOW) said it would purchase Rohm and Haas (NYSE:ROH) for $18.8 billion set a bullish foundation for stocks. ROH stocks soared 64% on the news. If there are bargains to be had in the large-cap arena, certainly there are also bargains in the small caps, and that type of thinking helps underpin investor psychology.

Indeed, one of the biggest percentage movers today in small caps was Excel Technology (Nasdaq:XLTC), which jumped 36% on news that the firm would be acquired by GSI Group (Nasdaq:GSIG) for $360 million in cash. Other small caps of note included Intervoice, Inc. (Nasdaq:INTV), which rallied 16% in the wake of earnings news. Ruby Tuesday (NYSE:RT) jumped some 20% on an improved outlook. On the downside, FCStone Group Inc. (Nasdaq:FCSX) tumbled 41%, gapping lower on unusually heavy volume on disappointing earnings news. Cogo Group (Nasdaq:COGO) collapsed 45%, also gapping down on brisk turnover as the company produced a downbeat assessment ahead of releasing earnings.

Looking ahead to Friday’s action, the market will get a chance to react to consumer sentiment data from the University of Michigan survey at 10 am ET. Important price data in the morning and Treasury budget details in the afternoon are unlikely to attract much trading attention. As for the charts, a sharp rally Friday would help any potential bottoming arguments, but the overall structure retains a bearish bias. Any close below 660 would amplify the bearish picture and intensify the equity heat on losing longs.