Surging oil takes bite out of strong durables data

Kevin Pendley | Aug 27, 2008 10:03am EDT | Comment

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Small-cap stocks struggled to hold higher ground in morning trade, with support from a strong durable goods report offset by a big rally in crude oil prices and lingering concerns about the banking sector. At 9:55 a.m. ET, the Russell 2000 (NYSE:IWM) was up 1, or 0.14%, at 724.51.

The durable goods report topped analyst expectations, with the headline number at 1.3%, well above the forecast for a meager rise of 0.1%. The upside surprise in orders sparked a trend reversal in stock index futures ahead of the open, with S&P 500 futures gaining more than four handles shortly after the report was released. Still, it should be noted that the durables data tends to be volatile, which could dull some of the bullish impact from the report. When stripping away the transportation component on the durables release, the number was still up 0.7%, which was a positive signal. The transportation orders include huge ticket items like airplanes, which create big swings in the headline number, so many traders and analysts will focus on the ex-transportation figure for a clearer picture of business spending. The yield on Treasury products was climbing fast this morning (meaning Treasuries themselves were lower) after the data surprise, hinting that the market was starting to consider rate hikes down the road.

On the Fed policy front, Atlanta Fed President Dennis Lockhart gave a speech on inflation this morning, and said that headline CPI will peak near the July level and that the current Federal Reserve monetary policy approach is consistent with an easing in overall inflation. Reading between the lines, it looks like the Fed leans toward protecting growth at this stage and will keep rates on hold for some time.

Crude oil prices were on a rampage this morning, shooting more than $3 a barrel higher, climbing back above $119 as energy traders build a weather premium into the market just in case Hurricane Gustav plows into crude oil and natural gas production areas in the Gulf of Mexico, which would pinch supplies. The Gulf area accounts for some 25% of U.S. crude production and 15% of natural gas output.

Looking at those Gustav concerns, Scott Fullman, director and derivatives investment strategist with WJB Capital Group, noted that implied volatility in the United States Natural Gas Fund spiked dramatically Tuesday and that activity was brisk in the Sep 40 calls (about $1.50 over the closing price). Fullman said that a lack of liquidity ahead of the holiday weekend increases the chance for volatility surrounding the Gustav event. Crude oil prices also could have a volatile response to the weekly inventory numbers, which are expected to show a build of about 1 million barrel in crude stocks. The report comes out at 10:35 a.m. ET.

The rise in crude oil prices likely stalled a comeback in the U.S. dollar after the durables surprise, and the greenback was down about 0.5% against the euro into the U.S. stock market opening. Several commodity markets were seeing a bid this morning, helped along by the soft dollar tone. Gold, coffee and cocoa were all seeing decent gains so far.

Playing a role in market psychology this morning are the never-ending worries about the credit crunch and its impact on financial and banking stocks. The banking issue was back on the front burner on news that the Federal Deposit Insurance Corporation (FDIC) said that the level of troubled banks is at the highest point in five years. The Wall Street Journal reported that the FDIC might have to borrow money from the Treasury to work through bank failures. Just last week, Columbian Bank and Trust Company — a small bank in Topeka, Kansas, became the ninth bank to fail this year.

Broad market sectors on the rise this morning included oil refining and marketing stocks, homebuilders, thrifts and mortgage finance firms, coal stocks, oil exploration, gas utilities, gold and mining stocks. On the downside, leisure products, general merchandise stores and motorcycle manufacturers were under pressure.

Individual small caps on the move included a host of air carriers, including US Airways Group Inc. (NYSE:LCC), which tumbled 6%, and UAL Corp. (Nasdaq:UAUA), which gapped lower and shed 9% sparked by the brisk rally in energy prices. Brown Shoe Company Inc. (NYSE:BWS) was off 6% after slicing its outlook in tandem with reporting quarterly results. On the upside, SI International Inc. (Nasdaq:SINT), rallied 35% on news that the firm was being purchased by British firm Serco Inc. for $32 dollars a share, or $423 million.

The chart picture retains a top-heavy bias and Tuesday’s slide through important short-term support at 726 only adds to the bearish tilt. If the Russell slips through Tuesday’s lows at 716.65, then the next support point to watch is near 711.50, which marked a bullish reversal on intraday studies. If the market can right itself today and push back above 726, then the next resistance zone from there is near 734.