Two-Way Traffic Ahead for the Markets?

After what has likely been a painfully long stretch of one-way road, it appears that our furry friends may have spotted the one road sign they've been aching to find on their journey: Two-Way Traffic Ahead. As we've been saying for many moons now, the current one-way market is indeed rare. This type of joyride to the upside has definitely happened before, but it has also clearly confounded anyone expecting to see a more traditional two-steps-forward-and-one-step-back type of bull market environment.

While we are not ready to commit to the idea that the top is in and that the bears will control the game going forward, we will suggest that the current geopolitical issues in places like Libya, Bahrain, Tunisia, Morocco and Yemen are clearly enough to kick-start a consolidation/corrective/sloppy phase in which the market goes both ways for a while.

The question I was asked on a fairly long lift-ride at Loveland Ski Resort over the weekend was a good one: Why does Libya matter when Egypt didn't? The answer is simple - oil. Although the world has plenty of oil relative to demand right now, the bottom line in the market is traders are now applying a "risk premium" to crude contracts. And with that premium pushing Texas Tea to uncomfortable levels, the worry is that an oil spike/shock, when coupled with the tightening measures being applied in China, could push the global economy back into recession.

This is the way the oil game works. As the fear of what could happen rises, traders bid up futures prices. At some point in this process the traditional supply/demand factors do come back into play. But until then, it's all about the news.

To put the oil situation into perspective, I read over the weekend that Libya, which is something like the seventh largest producer in OPEC, has capacity for something like 1.5 million barrels of oil a day. And given that Saudi Arabia currently has excess capacity of around 3.5 million barrels a day, what happens in Libya really doesn't matter much from a global supply standpoint.

However, the big fear is that the rage against the machine that is occurring in the Middle East will spread to places that DO matter such as Iran or even Saudi Arabia. Although wholesale changes in the Middle East aren't likely, the degree of success protesters enjoyed in Egypt does allow the mind to wander a bit in the "what could happen" category.

So, while we are NOT in the business of predicting what will come next in the market. It is a safe bet that the bears are going to get back in the game today. European markets were down approximately 1% - 1.5% on Monday and are down again today. As such, the U.S. markets have some catching up to the downside to do.

Is this the time to sell everything and head for the hills? Given the strength we've seen in the market recently, we'll guess that the answer to that question is no. However, we can expect the dip-buyers to "stand aside" for a bit and wait for the market to come in a little. Normally, the market tends to pull back to the tune of 3% to 5% every once in a while in order to keep everybody honest. And with the sign suggesting that there is two-way traffic ahead, this is probably what we're in for.