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BOTTOM LINE: Overall, last week's market performance was negative as increasing worries over Iran, raised terrorism fears, earnings failing to meet elevated expectations and profit-taking pressured stocks. The advance/decline line fell, most sectors declined and volume was above average on the week. Measures of investor anxiety were higher. Moreover, the AAII % Bulls fell to 50.0, but is still above average levels. The average 30-year mortgage rate fell to 6.10% which is only 89 basis points above all-time lows set in June 2003. The benchmark 10-year T-note yield was unchanged on the week as economic data was mostly positive and measures of inflation decelerated further.
Small-caps outperformed again as the Russell 2000 made another all-time high on Thursday. Unleaded Gas futures rebounded as oil rose on Iran/Nigeria worries. However gas prices are still 37% below September highs even as refinery utilization remains below normal as a result of the hurricanes. Natural gas supplies fell slightly more than expected this week. However, supplies are now 16.3% above the 5-year average, approaching an all-time record high for this time of year, even as over 18% of daily Gulf of Mexico production remains shut-in. Natural gas prices have plunged around 41% in 5 weeks. Gold fell on the week, notwithstanding geopolitical concerns, as measures of inflation continued to decelerate and traders took profits.
I still believe prices for many commodities are being driven by fear and record capital inflows into commodity funds, rather than fundamentals. I continue to expect global energy demand destruction, decelerating economic growth and a significant increase in supplies into 2006 to push oil prices substantially lower from current levels. Elevated prices related to Iran only make this outcome more likely. Any temporary spike in energy price due to an attack on Iran or Iranian halt in oil production would likely be less severe and more temporary than most expect as speculators are already pricing in a substantial OPEC production disruption. This scenario would also likely lead to a Fed rate cut.
Earnings growth for the fourth quarter is on pace to rise 13% year-over-year, good by historic standards. Some disappointing guidance is likely just an attempt to lower the bar for companies to exceed estimates this quarter. The ECRI Weekly Leading Index made another cycle high and is forecasting continued healthy US economic activity. While volatility will likely increase going forward, I still expect the S&P 500 to return 15% this year, notwithstanding any temporary weakness related to issues with Iran. High single-digit earnings growth, average economic growth of around 3%, an end to Fed rate hikes, low long-term interest rates, lower energy prices, a healthy labor market, a more sustainable housing market, p/e multiple expansion, a stable dollar, decelerating inflation, increased corporate spending, rising demand for US assets and a lifting of irrational pessimism should provide the catalysts for strong gains this year.
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