The market has been very strong for most of the second quarter, nearly erasing its first quarter losses.  The S&P 500, NASDAQ and Dow have all approached their 200 day moving averages in recent days and now, perhaps with earnings season officially in the rear view mirror, are taking a breather.  T Boone Pickens’ statement this morning that oil could hit $150 per barrell this year is giving the markets an additional reason to pause or at least to be cautious about breaking through these intermediate term resistance levels.

Our view continues to be that there will be no recession, but that there will likely be very little recovery as well.  While many commodities are approaching bubble like levels, we also know that bubbles can have a mind of their own.  Nevertheless, many emerging market economies, including China, are facing very high rates of inflation and significant pullbacks in their stock markets this year.  If we were to hazard a guess, we wouldn’t be surprised to see a blow off in oil sometime around the Beijing Olympics, when their government may start to pullback on their fiscal stimulus, including their large subsidy of energy prices.

The producer price index was released this morning, showing that the core level rose 3% year over year, the highest level since 1991.  Interestingly enough, this also coincided with a period of economic weakness for the United States and a recession.  We would be hard pressed to believe that higher energy and food prices won’t at least partially be passed on to consumers, but we’d also point out that it isn’t atypical for prices to peak during periods of economic weakness, as was the case in 1991. 

If we’re right about China cooling off, we could see commodities pullback significantly from current levels.  While there is a great deal of chatter about the inflation numbers being rigged, we would point out that the bond market doesn’t seem to be too concerned.  Interest rates continue to be very low and to be sure, aren’t nearly at the levels last seen when many commodity prices were this high.  The difference likely has to do with the fact that world economies are far more open than they were in the 70’s and 80’s, and that access to cheap labor is not only abundant, but quite fluid as well.  

Our no recession, no recovery view leads us to companies whose growth is tied more to innovation rather than the ebbs and flows of the domestic economic cycle.  We are big believers in the industrialization of the rest of the world, but would exercise some care given the parabolic moves in many stocks, which may partially be related to the updraft in commodities. 

As with all things, finding the appropriate balance is key.