Thursday, November 19, 2015

How Low Can Oil Go?

Today, investors trade off of gains in Wednesday from the release of the FOMC meeting minutes that supported rate hikes in December. As a result, the S&P 500 gained 1.35% at the signal of stronger economic growth as well as the conveying the belief that rate hikes are the right move. Some of the more hawkish Fed members already voiced regrets of not raising rates earlier and the tide seems to be turning in their favor. In my opinion, the major delay of rate hikes this year has splotched Janet Yellen's credibility as a central banker who can rule on the middle ground. Her decisions demonstrate her dovish tendencies in FOMC meetings which may have appeared desirable coming out of the financial crisis with a sizable unemployment but not during stabilization periods of the business cycle. While most lost faith in the free market system during 2008, it remains the single most effective pricing mechanism for the value of goods and the value of capital. The Fed cannot facilitate limitless growth. Moving into Thursday's trading, muted movement caps off gains earlier this week as a bullish trend trails off with lower volume throughout the market. Despite opening higher, the S&P 500 trades around 0.00%  at midday with small bearish undertones. The NASDAQ is trading slightly higher at 0.16% as tech companies have their rallies muted as well. European and Asian stocks show a little more bounce on Thursday with the Euro STOXX 50 up 0.50%, the China Shanghai Composite up 1.36%, and Nikkei 225 gaining 1.07% on the day. Global stocks in these markets are most likely responding to a call for more European stimulus which will trickle into major importers that are in the Asian countries. MSCI Emerging Market Standard indices are just slightly negative with losses of -0.13%. Gains from the emerging European nations counter the losses in the rest of the developing world. Looking at yield spreads over Treasuries, one can observe the effect of the last FOMC meeting and the minutes just released. European 10-year bonds have dropped 13.85 basis points below the Treasury 10-year in November alone. Currently, only two countries in Europe have higher 10-year yields, Greece and Portugal, who have both experienced financial pressures over their debt in the recent past. Stimulus programs from Draghi will continue to dilute the yields in Europe making U.S. bonds look appealing due to their higher yields. Dissection of the markets will reveal lagging securities in the industrials and energy sectors which have been the notable industries dictating overall movement in almost every trading session. Leading losses in energy is the mid-sized Chesapeake Energy Corporation with a decrease of -9.83%. The company headquartered in Oklahoma with assets across the U.S. has been ravaged by the supply glut with YTD losses of -72.36% compared to the S&P Oil and Gas Exploration and Production Index which has YTD losses of -22.54%. With the energy losses, the healthcare services industry is also weighing on stocks with Tenet Healthcare Corporation leading those drops trading -8.26% lower. On the other side of the markets, the consumer non-durable and transportation industries lead gainers with stocks there jumping just over 1%. The biggest gainers on the day were Keurig Green Mountain at 18.17% and the J. M. Smuckers Company at 7.21%, both of off positive earnings surprises that have been the story of gains in October and the beginning of November. The gains from these consumer non-durable firms reflect the bullish trend elicited by growth in U.S. retail sales. October retail sales grew very slightly, but it represented the efforts of the economy to reverse the effects of the global slowdown. Higher numbers were expected as many retailers and consumer non-durable companies had positive earnings surprises at the end of Q3 and lead the bullish trend we've seen in the last month and a half.



As market technicals begin to slow down after an upturn in October, both crude oil benchmarks have slowed down into trading in a tight range about $5 wide. On the day, Brent crude gained just 0.25% while WTI dipped into the $30s after a -0.37% left the price at $40.61. This is one of the lowest prices since it finished its "summer plunge" in August. This chart shows WTI price from the end of Q2 to the beginning of Q4. Concerning overall trends, three periods can be extracted and analyzed as clear technical trends that analysts have scrutinized over the 2015 year. The first trend, starting in the summer and ending at the close of August, saw trading dip to the high 30's where a clear bearish trend is extrapolated. Here, momentum and reversals built up in favor of a rebound by the end of Q3. Curiously, major gains paired with the popping of the Chinese stock bubble where global demand appeared in peril. Most investors trading bullishly at the end of August responded to technicals that signaled a reversal. RSI showed that the contracts were oversold, and the Chaikin Money Flow graph reveals a reduction in shorts that broke the weakness of supply and spurred buying into long-term positions and the realizations of shorts. That marks the beginning of the third technical period where trading enters consolidation and the formation of a small head and shoulders formations. The period is relatively short but was distinctly different than the summer trend. Volume levels around then drifted at bullish levels, but demand faltered and never become even slightly overbought (RSI around midway). The MACD line showed no major reversal with 4 or 5 crossover points within 2 months. The resistance and support levels between the dotted blue lines show the trading range that most investors were confident would settle trading into the end of the year. Unfortunately, waning demand and an acceleration of selling move the WTI benchmark into its third ongoing phase. After breaking out from the head and shoulder support, the spot price threatens to drop into sub-$40 territory. CMF shows a consistent increasing of bears suggesting that the trend hasn't tapered off into consolidation yet. RSI shows no evidence of  significant momentum in the other direction either. I suspect that trading will be a bit more bearish in the coming weeks as broad weakness will hit the market will soft losses. Another interesting thing to notice is the type of broad activity in the markets that moved in the background during each of the periods. Over the first period in the summer, U.S. and global stocks traded mostly bullish and flat with the August correction a notable event during that timeline. In period two, the bullish rebound helped energy stocks jump to new highs for the last half of the year. When equities took leaps and bounds in October, WTI was caught in a consolidation phase with muted gains even though demand recovered significantly;y through better economic statistics and positive earnings surprises. The start of November and the new third period defined here paired with equities tending to trade lower than the month before. Month-to-date losses for the S&P 500 amount to -0.23% with threats of more selling as rate hikes are likely. It's not a clear relationship, but a connection may be worth exploring for prediction purposes. On the other hand, I might add that WTI price cannot go much lower as even bottoms around $35 look dangerous to oil and gas revenue streams. If the trend develops like a bearish head and shoulders, there should be some kind of retracement of the height of the head which is measured at approximately $6.73. So going forward consider these Fibonacci retracements. Are they plausible? Is there enough momentum?

Height of head: $6.73
  • 38.2% = $2.57    Low: $40.45
  • 50% = $3.37       Low: $39.65 
  • 61.8% = $4.16    Low: $38.86
  • 100% = $6.73     Low: $36.29

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