MarketView for December 30

Summary

Wall Street can see the end of the year and most of the players are already on vacation until the first trading day of the New Year. As a result the major equity indexes closed slightly lower on as a trio of better-than-expected economic data wasn't enough to entice the few buyers still hanging around to take on much risk in a market that has already chalked up some pretty impressive gains. The S&P 500 index is already up 6.5 percent so far this month, putting it on track for the best December since 1991.

Nonetheless, the reports regarding the labor market, business activity and housing all showed surprising strength. New claims for initial unemployment benefits in the latest week fell to their lowest level since July 2008; while a report from the Institute for Supply Management-Chicago showed business activity in the Midwest hit its highest level since July 1988. The November pending home sales number was also higher than expected.

Technical indicators such as the S&P 500's relative strength index and elevated levels of bullishness are leading some investors to call for a pullback. The S&P is up more than 14 percent since August, contributing to a reluctance to make large bets as light volume leaves the market more susceptible to volatility.

February crude futures fell 1.9 percent to $89.35 per barrel after the latest inventory data, though the drop had little impact on energy companies.

Unemployment Falls

The number of people applying for unemployment insurance fell to its lowest level in nearly two and a half years, a sign that the job market is slowly improving. Applications fell by 34,000 to 388,000, the lowest point for that statistic since July 2008, the Labor Department said Thursday. The number of applications has either fallen or remained unchanged in five of the past six weeks.

With fewer than 425,000 people seeking unemployment benefits it is hard to deny that there is some degree of modest job growth occurring. However, there are many economists who hold the position that applications need to fall consistently to 375,000 or below to bring down the unemployment rate. Applications for unemployment benefits peaked during the recession at 651,000 in March 2009.

The latest report, which covers the week with the Christmas holiday, is considered by some economists to be less reliable than most. One reason is that many state offices close for at least one day. Other seasonal factors make the report more volatile. Nonetheless, a Labor Department analyst was quoted as saying that there were no unusual factors affecting the report and that it considers the impact of the holiday. Furthermore, what is key to the equation is the undeniable downward trend.

New applications for unemployment insurance are the closest thing to a real-time snapshot of the job market. They reflect the level of layoffs but can also indicate whether companies are willing to add workers. The four-week average, a less-volatile measure, fell by 12,500 applications to 414,000 for the week ending Dec. 25. That's the lowest level since late July 2008.

For most of the year the number of new applications was about 450,000 before dropping below that number in November. The four-week average has fallen by more than 40,000 in the past two months — a sign that hiring could accelerate in the coming months. Meanwhile, the December jobs report will likely indicate larger job gains. The report comes out on Jan. 7.

Separately, the number of people who signed contracts to buy homes rose in November, the fourth increase since contract signings hit a low point in June. The National Association of Realtors reported on Thursday that its index of sales agreements for previously occupied homes increased 3.5 percent last month from October. Still, this year's pace of completed home sales — which the Realtors group measures in a separate report — is shaping up to be the slowest in 13 years.

Historically low mortgage rates have done little to boost the struggling housing market. This week the average rate on a 30-year fixed mortgage rose to its highest level in seven months. It was up to 4.86 percent from 4.81 percent in the previous week, mortgage giant Freddie Mac said. It had been 4.17 percent last month, a 40-year low. The total number of people receiving unemployment benefits rose in the week ending Dec. 18 to 4.13 million.

That doesn't include millions of unemployed workers receiving extended benefits under an emergency program set up during the recession. About 4.5 million people are receiving extended benefits for up to 99 weeks. All told, nearly 8.9 million people obtained unemployment benefits in the week ending Dec. 11, the latest data available.

Oil Likely Headed To $100 per Barrel

As I have forecasted for the past 8-10 months, the price of crude oil is positioned to hit $100 per barrel and above. The price has already gone above Saudi Arabia's preferred $70-$80 range and yet OPEC is unlikely to stop the rally.

At meetings this month -- a full conference of the Organization of the Petroleum Exporting Countries in Quito and talks among Arab oil ministers in Cairo -- oil producers stood by OPEC's two-year-old set of output curbs.

Yet, even with prices of $100 -- not far above a 26-month high of $91.88 hit this week – the price of crude is unlikely to damage the economy and would not mean OPEC should pump more if the increase could be traced to simply speculation rather than any shortage, ministers and officials have said.

"If it goes to $100 due to speculation, OPEC will not move," OPEC Secretary General Abdullah al-Badri said this month. He also said the organization did not want oil to achieve that price level.

There are two factions regarding the fundamental strength in crude prices. One faction says that as the world economy recovers, it will in turn drive up fuel consumption. Then there are those who focus on differences between today's relatively well-supplied market and that of 2008, when oil sped to its all-time high of nearly $150 a barrel.

"It remains to be seen whether prices are responding to short-term weather conditions or longer term demand and monetary issues," said Sadad al-Husseini, an oil analyst and former top official at Saudi state oil giant Saudi Aramco. "Given the still abundant oil inventories, it wouldn't make sense for OPEC to over-react on what may be a very transient condition."

By the time any extra oil reached consumers, demand could be lower after the peak demand of the northern hemisphere winter. That would add to oversupply in a market, which for all the nominal strength is still in contango, a structure in which a relatively cheap front-month contract encourages stock-building.

Meanwhile, OPEC caution recalls its action ahead of the record bull run of 2008, when it was slow to add oil. Husseini and many inside OPEC have said dollar-denominated oil is cheaper than it seems because the dollar has fallen.

"Prices have not yet risen to $100/barrel and there is nothing mysterious about $100/barrel," he said. "It equates to no more than $80/barrel in 2005 dollars, once current prices are corrected for inflation."

In nominal terms, oil has risen 35 percent from a low hit in May and this week's peak was around 15 percent above the price at the end of 2009. The current rally set in around September after the U.S. Federal Reserve embarked on its latest quantitative easing, which has triggered a wave of buying across financial markets.

Data from U.S. regulator the Commodity Futures Trading Commission released this week showed money managers extended their net long crude oil positions to a record. Still oil's strength has been modest by comparison with commodities that face looming shortfalls, such as copper, which has touched a series of records.

As oil began to rise in September, traders were contemplating record fuel inventories in the United States, the world's biggest oil user. Supplies have since fallen, although a deep draw in crude stockpiles could have been in part because of year-end tax positioning. In addition to stocks, OPEC has significant spare capacity, which it has pegged at around 6 million barrels per day (bpd).

Iraq, which is exempt from the OPEC system of supply curbs as it recovers from war and sanctions, has huge scope to grow. Oil analysts have disputed it can meet a capacity target of 12 million bpd in around seven years, but even a slower increase would provide much of the extra oil needed to meet any rise in demand. Its new oil minister said it aimed to increase output to 3 million bpd by the end of 2011, up from around 2.6 million bpd.

Absolute demand would hit a new high, but the rate of demand growth is slower than the record of 3 million bpd in 2004, according to figures from the International Energy Agency.