High crude oil prices have created a new "petrophobia" for the stock market, but traders are watching for an even broader markets trend to guide stocks in the week ahead.
They say the dollar's move up in the past week, the parallel rise in Treasury yields and the exodus of money from commodities markets, including energy, would be fundamentally good for stocks -- if it continues.
"The sentiment has really changed, and you can see a concerted effort to get the dollar a little stronger. We've seen that in terms of the weakness in commodities prices, and that in itself will keep the stock market going forward," said Tim Smalls, head of U.S. trading at Execution LLC.
In the week ahead, speeches from Fed Chairman Ben Bernanke and a full calendar of economic data, including May's employment report Friday, will get attention. There are a few earnings, and the big cancer drug conference, ASCO, should start making news from the biopharma industry over the weekend.
In the past week, the Dow gained 1.3 percent and the S&P 500 gained while oil lost 3.7 percent to $127.35 per barrel. Gold lost 2.8 percent. The yield on the 10-year rose to 4.046 percent and the dollar gained 1.4 percent against the euro.
"I think the dollar rally is going to continue," said Smalls, who expects commodities to remain under pressure. But, of course, there are caveats.
"A lot of it rests on global developments. We've definitely seen some demand destruction in the oil complex, and that's really taken center stage," he said.
"If something happens over the weekend or at the beginning of next week, something geopolitical, that spikes the price of oil, that spikes the price of gold, that's going to reverse it. We're in a very tenuous situation, and we're dealing with commodities that are very fluid."
Miller Tabak's Tony Crescenzi said in a note today that the dollar could rally because of improved conditions in the credit markets, signs of a shallower recession, and expectations for eventual Fed rate hikes. But he does not believe the dollar is in a real breakout, and he does not expect the dollar rally to be significant because of the weak economy.
As the market enters a spring/summer doldrums ahead of the next earnings period, PNC strategist Bill Stone says he expects the markets to focus on the high commodity prices and respond with volatile trading.
"I don't necessarily expect calm," he said. "I do think you're going to have days, even if this is the peak in commodities, where it will weigh on people. You're going to still see some bad data."
Stone says he expects moderating inflation but that would change if there were signs of a wage/price spiral, as in the 1970s. Stone says if there is a jump in inflation, though, stocks could be the place to be. "At the end of the day, the best hedge against inflation is [to] own stocks."
In a report Friday, he cited a study by Dimson, Marsh and Staunton that found that stocks provided the highest real return across the stock, bond and cash returns of 16 countries over 101 years of data.
"This even held for countries that suffered from hyperinflation," Stone wrote. "It is logical that stocks adapt to inflation (albeit with a lag) because earnings and future dividends eventually start to rise at the level of inflation and offset its negative valuation impact."
Many strategists have said they expect to see increased earnings warnings heading into the second-quarter reporting period, which could be bad for stocks. Stone doesn't necessarily see it that way. "Falling earnings isn't necessarily going to make the stock market go down," he said. "...the weakening economy will be viewed as positive because it puts a stake in oil and it maybe puts a stake in the heart of inflation."
Sectors he likes includes globally exposed industrial companies, like Honeywell, for instance, and consumer staples.
The big number in the coming week is the May jobs report, released 8:30am ET Friday morning.
The week has a busy start with ISM manufacturing data and construction spending Monday. On Tuesday, factory orders are reported at 10am and auto industry monthly sales are reported throughout the day. ADP's private sector jobs data is released Wednesday morning, as is productivity and costs and ISM non manufacturing data. Weekly jobless claims are reported Thursday. Friday's reports also include wholesale trade for April and consumer credit.
Fed Chairman Ben Bernanke speaks to the International Monetary Conference in Barcelona, Spain Tuesday at 9am ET. His topic is the economic outlook and he is taking questions. He speaks again on Wednesday at 2:45pm to a Harvard alumni group at Harvard University. His topic that day is "Economic Challenges: 1975 and now."
Treasury Secretary Hank Paulson is in the Middle East and speaks overnight Sunday on open investment in Abu Dhabi.
Fed Governor Randall Kroszner speaks Friday at Boston College on financial market developments and credit conditions at 8:45am. Philadelphia Fed President Charles Plosser speaks on financial stability in New York at noon on Thursday. Chicago Fed President Charles Evans speaks in Chicago at 11:15am on Friday.
Thornburgh Mortgage and Lululemon Athletica report Monday. Home builders Toll Brothers and Hovnanian report Tuesday. Williams Sonoma reports Wednesday, and Del Monte Foods, Trina Solar; National Semiconductor and Smithfield Foods report Thursday.
Bristol Myers and ImClone are expected to make headlines at ASCO this weekend on the use of erbitux for lung cancer. CNBC's Mike Huckman says the big question is how much longer do patients using erbitux and chemo survive.
Other conferences include Sandler O'Neill's global exchange and electronic trading conference in New York Thursday and Friday. Goldman Sachs holds a lodging, gaming, restaurant and leisure conference Monday. JPMorgan has a basics material and industrial conference Tuesday. Keefe Bruyette holds a diversified financial services conference Wednesday, and Raymond James holds its spring investors conference that day.