Stock Market Slides Down an Oily Slope
Energy stocks and Putin’s Russia get clobbered, but U.S. GDP might rise a bit. Techs take a beating, and investment pro Louise Yamada thinks the technical damage to the overall market will take some time to repair.
Praise John from whom oil blessings flow,” went a spoof of the Doxology, a traditional English hymn of praise sung by students at the University of Chicago more than a century ago to one of that institution’s main benefactors, John D. Rockefeller.
Oil, of course, has been the basis of the family’s considerable fortune, so it was more than a bit ironic that its $860 million philanthropic foundation, the Rockefeller Brothers Fund, last month announced that it would divest itself of investments in fossil fuels.
Had the foundation dumped the stocks at the time of the announcement, it would have been a canny bit of market timing. The Energy Select Sector SPDR exchange-traded fund (ticker: XLE)—whose largest component just happens to be ExxonMobil (XOM), the descendant of Rockefeller’s Standard Oil—is down about 9% since then and off more than 15% from its recent peak in late June.
That coincided with the stunning slide in crude-oil prices, which last week met the common definition of a bear market with declines of 20% or more. West Texas Intermediate dipped to $83.59 a barrel, the lowest since mid-2012, while Brent crude broke through $90, to as little as $88.11, the lowest since December 2010.
The slump obviously is a bane to the big oil companies, oil-service companies, and especially the exploration-and-production outfits. But it isn’t seen as big a boon as in the past for the rest of the economy, despite the hoary notion that a price drop at the gas pump equals a tax cut for consumers.
According to an estimate by a major institutional investor (expressly not for attribution), the drop in energy prices might boost U.S. gross domestic product about 0.3%. But that’s only about half of the fillip that was seen prior to the vast expansion of North American oil production, which has been a positive for U.S. growth in recent years. Thus, there are also minuses from lower prices, especially for high-cost oil producers funded by hefty debt.
Meanwhile, the dollar’s surge is diluting the drop in oil prices for consumers in other countries, who pay for petroleum in their depreciating currencies. For instance, the 20% bear market in Brent translates to only about a 15% decline in euro terms. (To be sure, when the euro was strong, it mitigated the rise in oil costs.)
And the vise is especially tight for oil-producing countries that have seen the value of their currencies tumble in tandem with their petrol profits. It couldn’t have happened to a nicer guy than Vladimir Putin, with the Russian budget dependent on oil staying over $100 and the ruble already under pressure from sanctions over Ukraine.
For investors, the corresponding big break in oil stocks is reminiscent of the action of financial stocks in 2006, says Louise Yamada, who heads the eponymous Louise Yamada Technical Research Advisors. That is, the financials peaked and faltered months ahead of the broad market averages, which topped in October 2007 as the first distant rumbles of the financial crisis were being felt.
Indeed, she writes in her monthly missive to clients, “energy appears to us technically in a structural decline.” Expanding on that in a phone chat, she says that the sector suffered a breakdown in relative strength after six years of waning strength, relative to the rest of the market. And after a spate of basically sideways movements, a number of energy stocks have suffered spectacular spills, including Anadarko Petroleum (APC), which she notes has tumbled from about $110 to under $90.
The waning relative strength of the energy sector was but one of the discordant notes sounded as the major averages were setting records, as did the Dow Jones Industrial Average and the Standard & Poor’s 500, or new cyclical highs, as did the Nasdaq Composite, not so long ago. Most prominent has been the laggard performance of small-capitalization stocks, a mostly All-American cohort thought to be a redoubt from the upheavals abroad. The iShares Russell 2000 exchange-traded fund (IWM) last week nevertheless entered official correction territory and is 13% below its 52-week high.
Louise also points to the rising numbers on the 52-week lows list, which exceed the tallies seen during pullbacks in 2013 or 2012, but are approaching totals from the 2011 selloff. Finally, the most attractive sector—technology—also is getting caught in the downdraft. (Ever the lady, Louise recalls the ribald description of this process by my illustrious predecessor in this space, but asks that it not be repeated.)
Techs got blasted on Friday after a revenue warning by Microchip Technology (MCHP) sent its shares plunging 12.3%, which clobbered the Market Vectors Semiconductor ETF (SMH) by 6.6%. Even old tech such as Intel (INTC) was smacked 5% and Microsoft (MSFT), 4%, on Friday. Google (GOOGL) took a 3% hit and entered correction mode, although Apple (AAPL) held the $100 a share level as Carl Icahn presses for more share buybacks.
Louise thinks that, in the stock market’s current oversold condition, there could be intermittent rallies. After all, Wednesday was the Dow’s strongest day of 2014, and Thursday was the worst. But she would be suspicious of any pops. The technical damage inflicted on the market, she adds, will take some time to repair.
By themselves, the bungee-jumping moves, with harrowing drops interspersed with big, one-day upward bounces, don’t say much, she says. More importantly, the false breakouts in the major averages contrasted with the breakdowns in various groups. Even sectors that would be expected to rally—transportation stocks amid declining fuel costs, defense stocks amid rising geopolitical tensions—have failed to participate.
At a minimum, it’s not time to buy the dips blindly. With investors having given back some $1.5 trillion in wealth in U.S. stocks in the past month or so, according to Wilshire Associates, their ability or willingness to do so may also be rather diminished.
The clear message running through all of the global markets, from equities to commodities to currencies and bonds, has been slowing growth and disinflationary pressures. In addition to the selloff in stocks on Wall Street and well beyond, and the slump in oil, this is being evidenced in the strength in the dollar and the further descent in bond yields.
Treasury yields dropped to their lows of 2014 last week, with the benchmark 10-year note falling to 2.30% and the 30-year long bond hovering just above the 3% level. The declines came in tandem with those in European bond markets after German economic indicators showed a much sharper slowdown than expected, indicating that the Continent’s strongest economy is possibly teetering on the brink of recession.
The slide in bond yields also got a push from the minutes of the Federal Open Market Committee’s September meeting, which showed a sensitivity to the restraint exerted by the dollar’s rise. Markets inferred that to mean eventual hikes in the federal-funds target would be pushed farther back into 2015, which spurred Wednesday’s one-day-wonder rally.
The interest-rate futures and options markets—where the real bets on Fed policy are laid, as opposed to paper forecasts—already had been moving in that direction before the FOMC minutes were released on Wednesday. And while the consensus of economists calls for the first increase in the fed-funds rate—from the current 0% to 0.25% target set back in December 2008 at the depths of the financial crisis—to take place in the first half of next year, the market continues to think differently.
Based on the futures market, there’s only a 36% probability of a rate hike at the July 28, 2015, FOMC meeting. Only by the Sept. 17, 2015, gathering is a rate hike deemed better than even money—a 57% probability, according to the CME’s calculation.
Even with the receding likelihood of an early Fed hike, the Dow Jones Industrial Average ended the week in the red for 2014. And that’s before earnings reports for the third quarter mostly have started rolling in.
While companies have engaged in the usual tack of lowering profit targets to make them easier to beat, Barclays analysts think that estimates haven’t been adjusted enough to reflect the head winds, including the dollar’s rise and economic weakness overseas. More importantly, they don’t think that guidance for 2015 will be positive.
Capital spending, one of the hopes to spur growth, might also disappoint. Energy accounts for 27% of capital expenditures, and with the slump in oil prices, the Barclays analysts say they will be “listening closely” to commentary about future capex. So will investors, for this and other clues about the future, which suddenly seems far less certain.