Trying to make sense of what happened on Friday only raises more questions. So in an attempt to put things in perspective I filtered through the debris for what I view as the key points to watch both now and on the horizon. Let’s start with the biggest issue at hand currently, oil prices. Crude did drop 3% or $4 a barrel and didn’t rally anything worth noting. In fact the energy sector rose 2.5% in response. Looking at the chart of (AMEX: USO), US oil fund,

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There have been three nice pullback and rallies since the breakout in February. This fourth rally has been climatic and volatile. This could be the blow off top or an attempt at one. In either case crude is ready for a pullback. You can see on the chart support on a significant pullback and consolidation would be near the $100 mark or about 10%. This is one on our watch list that continues to frustrate both you and me.

Financials have been beaten like Big Brown at the Belmont. Granted the news continues to be disappointing, but at some point there will be survivors to rebuild this sector of the market. No, I am not ready to run out and put my money to work but at some point this will improve and there will be plenty of opportunity here. Rationale, in order for the economy to grow there has to be lending. If you look at the 2 year Treasury yields they are rising. Yesterday they moved back to 2.71%. This indicates two things, first the demand for money is growing and second, there is a potential Fed hike on tap. Both are positive for growth. I would continue to watch for improvement in this sector. (AMEX: IYF), iShares Financials is testing the March lows, while the (AMEX: IAT), iShares Regional Banks and (AMEX: KBE), (NYSE: KBW) Banks both set new lows yesterday.

Technology (AMEX: IYW) and small cap (AMEX: IJR) gave up leadership the last two days. Money went flying back to energy, agriculture and commodities. While it is easy to see why with the noise surrounding the markets of late, these are still two sectors to like longer term. On SectorExchange.com we track all the sectors everyday and I continue to like both of these sectors long term. They are great for dollar cost averaging or laddering into longer term positions. Watch these for opportunities on this pullback.

Treasury yields ($TNX) are on the rise. This is a clear indication to protect your bond positions. I would be more inclined to use high yield bonds or muni’s at this stage of the game. In fact if taxes are going higher as everyone is projecting with the election then muni bonds would be even more attractive due to the tax advantaged dividends. I am looking for the 10 year bond to move to 4.5% near term and the Fed to hike rates by 50 basis points prior to year end.

Agriculture and commodities are on the rise again with the change in sentiment over the last few trading days. I am very cautious of that move and if I were to play it I would be very short term sighted on the move. I am not saying they are going down in dramatic fashion, but they are not likely to go a big run to the upside. I am not one to tell you not to play the move, just play it with discipline. Remember pigs get fat, hogs get slaughtered.

Last and certainly not least, is the economy. To put this is issue in perspective, we have an issue on tap that most people are placating and not giving enough credence to – inflation. It is the perfect scenario with a weak dollar, slow growing economy and rising energy prices. From my view the biggest issue facing inflation is energy prices. They are acting as a governor on supply and demand. Demand slows in response to energy prices along with production. But, if we get growth at any rate it puts pressure on supply, pushing prices higher. The economy wants and needs growth and this tightrope we are on could ignite inflation and in response push the Fed to hike rates potentially stalling growth. Oh what a tangled web we weave… This is one of the keys to the second half of the year and a situation to watch closely. One thing that could help this picture dramatically is $100 crude.

I will be discussing and expanding on all of these in the coming weeks. There is plenty happening currently in the overall market and pouring out my thoughts helps explains my actions as we move forward.