Stocks extend gains on sudden downward reversal in crude

Kevin Pendley | Aug 28, 2008 1:43pm EDT | Comment

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Small-cap stocks extended the morning rise into mid-session, receiving a boost from a sudden reversal in course on crude oil prices. The day was already off to a solid start when economic data on growth came in above expectations. At 12:50 p.m. ET, the Russell 2000 (NYSE:IWM) was up 6.31, or 0.86%, at 739.26.

The volatile world of energy prices made an about face from morning highs near $120 dollars a barrel, slipping back to the $115 zone on reports that strategic petroleum reserves could be released if Tropical Storm Gustav crashed into key energy production zones in the Gulf of Mexico, stunting supplies out of that key region. Gulf output accounts for some 25% of U.S. crude production and about 15% of natural gas output.

The stock market got things off in rosy fashion this morning when second-quarter GDP came in at 3.3%, which was well above the forecast for a rise of 2.7%. The GDP report became yet another in a string of bullish data surprises this week, following consumer confidence Tuesday and durable goods orders on Wednesday. That said, some of these data series are volatile (durables and confidence) and others are relatively out of date (GDP), so clearly there are other forces at play providing a boost to the stock market.

One of those forces would appear to be month-end short-covering from hedge funds, and that buying interest has been magnified by thin volume conditions ahead of the final big summer holiday weekend in the United States. In addition to the short-covering push, financial stocks appear to be on more stable footing this week, with government-sponsored enterprises Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) bouncing on management changes at FNM and on ideas that the mortgage funding giants might not be in as bad a sharp as feared. FNM was up 12% at midday, while FRE was up 11%. Financial stocks in general were up nearly 3% and large bank stocks were up about 3.4%, both of which are solid one-day moves.

Looking at broad sector action today, thrifts and mortgage finance firms were the top performers, followed by homebuilders, tire and rubber stocks, diversified banks, forest products, specialty stores, investment banks, insurance and specialized REITS — which makes for a pretty diverse batch of bullish sectors. On the downside, energy names dominated the picture following the slide in crude oil, with oil exploration and production, gas utilities, oil and gas storage and oil drillers all slipping into negative territory.

In conjunction with the reversal in energy prices today, the U.S. dollar also found a bid, climbing back into positive territory against the euro, while holding near steady versus the yen. As the dollar picked up steam and energy prices slumped, other commodities also turned down, with the Commodity Research Bureau Index of 19 physical markets sinking nearly 2%.

Looking at the chart picture for the Russell, today’s push back above 739 was a positive development, even though volume has not confirmed the recent bounce off Tuesday’s lows. Still, the market pushed through minor trendline resistance off the recent peak and extended the rise through the 20-day moving average, which could easily spook short-term bears out of the market ahead of the extended holiday weekend. There is resistance on the way up from here, first at 742, then at 750. If the market starts to wobble today, there is minor support near 734, but the key test is back down at 726.

As for individual small caps on the move through midday, air carriers were a strong presence, relishing the sudden decline in crude oil prices. Small-cap carrier US Airways Group Inc. (NYSE:LCC) was up 16%, and larger-cap airlines such as Northwest Airlines Corp. (NYSE:NWA) and Delta Airlines Inc. (NYSE:DAL) were also prominent on the NYSE list of top percentage gainers. Dillards Inc. (NYSE:DDS) jumped 13% and Jo-Ann Stores Inc. (NYSE:JAS) was up 10% as several small- to mid-cap retailers were in positive territory following a batch of better-than-expected earnings results in the group. On the downside, FuelCell Energy Inc. (Nasdaq:FCEL) was down nearly 11% following earnings news.