- - Thursday, May 12, 2011


As we head further into the second calendar quarter, I find the stock market to be increasingly at odds with the economic data we have been getting.

Despite the slowing growth rates in China, continued weakness in the domestic housing market, signs confirming that inflation has ticked up recently, slower consumer spending amid high gasoline prices and the increase in new jobless claims over the past few weeks, the stock market has continued to grind its way higher.

In my view, the latest rash of economic data has confirmed a soft patch in the domestic economy. Combine that with slower than expected growth in China and … well, let’s just say that when growth in the top two economies on the planet is slower than expected only a few months ago, expectations need to be adjusted.

Expectations for certain commodities, such as oil, corn, wheat, soybeans and others, are being readjusted from arguably overheated or frothy levels. Those expectations adjustments are behind the bumps in the stock market during the past two weeks.

Aside from the economic soft patch, what else is fueling the drop in commodity prices? The recent buildup in gasoline and oil inventories for one and better than expected commodity crops is another.

According to the U.S. Energy Administration, U.S. crude oil stocks rose by 3.78 million barrels last week and gasoline stockpiles increased by 1.3 million barrels; this was head and shoulders above the 1.4 million barrel consensus increase for oil and the 200,000 barrel drop in gasoline inventories that was expected, according to Reuters News Agency. That buildup combined with growing indications of the aforementioned economic slowdown resulted in oil prices falling earlier this week.

Also this week, the U.S. Department of Agriculture released its May World Agricultural Supply and Demand Estimates, which called for U.S. corn production to reach 13.5 billion bushels in 2011. Such a level would mark the largest U.S. crop ever, outdoing the record 13.1 billion bushel corn crop in 2009. Despite the favorable headlines associated with that production forecast and the ensuing price fall in corn and other commodities, deeper in the USDA’s forecast we find that despite the record production forecast corn stocks will remain in very tight supply.

The pullback in commodity prices and commodity players, such as Corn Products International, Archer Daniels Midland Co. and Bunge Limited, have taken the froth out of the commodities markets for now. At the same time, however, rising concern about the strength of the economy has caused investors to move from economically sensitive stocks toward more defensive ones.

In the last week, shares of companies such as construction equipment maker Caterpillar Inc., Parker Hannifin Corp. and engine manufacturer Cummins Inc. are all down mid-single digits. By comparison, shares of more classic safety, slower growth companies, such as Kraft Foods, McCormick & Co., the Coca-Cola Co. and others are up nicely. Up even more are Boyd Gaming Corp., Ameristar Casino Inc. and others that fit into the “guilty pleasure” investing thematic I described a few columns ago.

Amid this near term sector rotation, my suggestion would be to do what a savvy and prudent investor does in times like this.

Understanding that the current quarter could be a short-term soft patch, examine which economically sensitive sectors and corresponding companies are poised to rebound in the coming quarter?

In more plain English, we might be able to use the recent weakness to get another bite at the proverbial stock apple. One such example is Trinity Industries, which has fallen from recent highs even though its railcar backlogs have surged and the outlook for rail traffic remains bright, particularly as gasoline prices remain well above year ago levels.

Do your homework, know your risk tolerance and good hunting.

Chris Versace, the Thematic Investor, is director of research at Think 20/20, an independent equity-research and corporate-access firm in the Washington, D.C., area. He can be reached at [email protected] At the time of publication, Mr. Versace had no positions in companies mentioned; however, positions can change.

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