Whether it’s the latest news on US-China trade, the impeachment inquiry, or an ongoing global slowdown, stock market sensitivity to headline risk has been on the rise in recent months.
Here’s what we discussed in our recent Technician and Big Picture segments on the Financial Sense Newshour. For audio, see Buying Opportunities Ahead, Says Louise Yamada.
The unexpectedly weak manufacturing figures for the U.S. were the main catalyst that pushed markets into decline early last week, Financial Sense Wealth Management’s Ryan Puplava noted.
“That presented an opportunity with oversold conditions for a buy-the-dip mentality,” he said. “We were right around some very significant levels, technically speaking.”
The S&P 500 was down almost 5% from the September closing high and down 4.1% since last Monday’s close, he noted. This highlights how deep the move was in just a couple of days.
Additionally, the jobs report last Friday was not stellar, which helped bolster the case for another 0.25% (or 25 basis point) interest rate cut by the Federal Reserve in their next meeting set for October 30, 2019. Currently, the probability of a 25 basis point cut is near 73%, and that’s up from 49% around two weeks ago.
ISM Not as Bad as it Seems
Last week’s reports weren’t pretty, but they didn’t really present anything new, Puplava noted. While it is true that we are officially in contractionary territory for 2 months in a row in manufacturing, we aren’t quite there yet in the non-manufacturing or services part of the economy, which comprises a much larger part of economic output.
However, based on the chart of manufacturing as well as services, both have been decelerating steadily for a year now and, as many headlines attest, the ISM manufacturing index is now at its lowest level in 10 years.
Factors behind these readings include slower global growth, trade policy uncertainty that constrains spending, dollar strength and expanded inventory levels, Puplava stated.
None of this is dire, however, because manufacturing is not a particularly large portion of the U.S. economy, Puplava noted. Moody’s did a correlation review recently between GDP and growth in manufacturing, and found that the correlation is less than 10%.
Having manufacturing in contraction isn’t a good thing, and markets do respond negatively to bad news there, but we have to put things into perspective, Puplava said. The equities market has held up mainly on the belief that the consumer and services industry can shoulder that burden of growth.
While services data also showed some slowing that spooked investors to a degree, it is still in positive territory. Caution is warranted, Puplava noted, but the labor market is still holding up and conditions aren’t recessionary yet.
“There are several headwinds facing the U.S. now, such as trade constraints, tight labor drop off, consumer confidence and a drop off from the fiscal stimulus from Tax Cuts and Jobs Act,” Puplava said. “But this is not to make things sound so dire or inevitably recessionary. As long as spending stays up … and the labor market is strong, we should be OK. It continues to warrant in our opinion a neutral stance towards risk.”
Kudlow and FOMC Reassures on Markets
On Friday, White House Economic Advisor Kudlow’s comments helped to calm markets, and offered some reassurance that we could see positive surprises this week.
Also, Boston Fed President and FOMC voter Eric Rosengren told CNBC that he estimates we will see 1.7% growth in the second half of this year, which is not a recessionary reading, Puplava noted.
Rosengren noted he is keeping an open mind regarding further rate cuts. It takes time for rate cuts to affect the economy, Rosengren added, and he essentially called for patience.
Fed Chair Jerome Powell also recently spoke at a Fed Listens event and said, overall, they think the economy is in a good place and it’s the Fed’s job to “keep it there as long as possible.”
Headlines Dominate Cautious Markets
With so much uncertainty over trade policy and other matters, financial markets are being driven by the news cycle, Louise Yamada told Financial Sense Newshour. Additionally, given the speed of communication these days, markets are prone to react to every little tweet, she said.
Technically speaking, signals are somewhat more ambiguous, she noted. We’ve been in a trading range for nearly 2 years, Yamada added, basically around the pivot low from December 2018.
We’ve been talking about consolidation or a major top, and it hasn’t yet become clear if this has happened yet. We could drop down toward 25,000 on the Dow, for example, and still be in an as-yet undefined consolidation period.
However, underlying technical indicators have been deteriorating as this trading range has progressed over the course of this year, she noted, with last week’s decline putting markets briefly into oversold territory.
“Our momentum indicator has moved into oversold,” she said. “Oversold conditions are the empirical evidence of selling pressure. And when you get into something that looks like it could be a more sustainable decline, you want to stay out of the way … until that oversold condition is alleviated, to suggest that buying power is coming back to the platform. … We want to stand on the sidelines a little bit until we see whether things can stabilize here.”
Bonds, Blue Chips and Yields
Right now, the yield on blue chip stocks is actually higher than bonds in many cases. Many companies on the Dow are paying dividend yields anywhere from 3-5%, versus 1.6% on a 10-year Treasury note.
This is possibly due to some of the recent buybacks, Yamada noted. However, some of the stocks paying these dividends don’t look that great, and some are rolling over.
Not all advances are created equal, she said. While some rallies may take stocks to new highs, some may run into resistance levels, and from there we can see secondary and tertiary breakdowns.
These rallies are then essentially dead cat bounces, she noted. We have seen some movement higher in energy and materials, and possibly even financials, she said, but these have been in structural bear markets and there hasn’t been anything that suggests this has changed.
Bonds are also tricky here, Yamada stated. The spring rally over 3% suggested that the rally in the bond market was coming to an end, but yields have since fallen.
“We had 36 years of falling interest rates, and it looked to us that crossing 3% was the first time we really had a slightly higher high in yields,” she said. “Now we’re at a very critical point, because we’re right near the low of 2016 and the equivalent low of 2012. Basing formations for interest rates coming out of deflationary periods can last from 2 to 14 years. This one’s practically 8 years long already. It’s possible that we’re going to have to see more work being done before we see rates move up. We would not like to see rates go below 1.4%, because then possibly the repair process has to start all over again.”
Possible Negative Rates Suggest Debt Overload
Fed rate cuts and recent talk have suggested we may see negative rates in the U.S. This would be a dicey development, Yamada stated. It is likely investors are looking for safety as interest rates elsewhere are turning or have been negative.
This is likely why we are seeing capital flows into the United States, Yamada said, as investors chase yields that are not yet negative. “It says to me that the world is over indebted and I find that a very distressing situation.”
The Fed is left with few tools to act here, she noted. It’s a dilemma we’re having to face, and unfortunately, as conditions have felt better since the 2009 recession, people have started to over-leverage themselves.
There is some room for Fed to lower rates again, Yamada noted. Foreign demand for U.S. bonds is likely what pushed rates down recently.
Yamada also sees gold is breaking out. It made a 6-year base and looks extremely attractive here. Technically speaking, its price pattern suggests that gold may not only equal the prior high around $1,900, but possibly even go higher over time, though not immediately.
“Keep your powder dry, cut your losses short, and don’t let your losses mount,” Yamada said. “If something starts to break a critical support level, don’t take more than a 7 percent loss. Try and move away when supports are broken, and let’s let the dust settle. There are only two losses you can experience in the stock market: a loss of capital or a loss of opportunity. If you can protect that capital, you can wait until there’s another opportunity, and you’ll have the cash to take advantage.”
Is an Oil Shock Possible?
Crude prices have been held down, and continue to decline even in the face of geopolitical risks. Now, we are at dangerously low levels of inventory, noted Dan Steffens, President of Energy Prospectus Group.
While everyone focuses on inventory reports, another big consideration is the number of days’ worth of supply that inventory would equal, Steffens added. Oil inventory reports need to be adjusted for inflation in usage, he stated.
We use 7 million barrels a day more than we did 5 years ago, he noted. We should look at inventory compared to its 5-year average. We’re now at 101 million barrels a day of refined products made from oil being consumed, and it just keeps going up every year.
Ultimately, we could be much closer to a possible oil shock than many assume is possible right now. While some point to high U.S. production rates as a buffer against such a shock, the reality is that oil prices are still set on a global stage.
If Saudi Arabia sees another attack that damages production, Steffens noted, while it may not hit the U.S. particularly hard, prices may still spike.
“We would eventually be impacted if that much oil was taken off for an extended period of time,” Steffens said. “I think you’d have to have oil well above $100 a barrel in that scenario. There’d be a bidding war for supply between China, India and Europe immediately that would send oil through the roof.”
Saudi Signals and U.S. Production Expectations
The Saudis moved quickly to signal they have excess reserves in a bid to calm markets and retain market share, Steffens stated. They also suggested that they will be able to bring production capacity back online.
This is likely possible, and the Saudis do have oil reserves stored around the world for shocks similar to recent attacks on their production facilities. This should help smooth out concerns around export capacity.
Productivity is essentially flat in the U.S. right now, as the active rig count has come down. Unless producers continually drill and complete more wells, Steffens noted, productivity is bound to go flat and is likely already in decline.
We were at 12 million barrels a day of production in December, and we’re just barely above 12 million barrels a day now, he noted. At the current active rig count, there’s no way we can be increasing production anywhere close to the original EIA estimates, Steffens said.
We’re unlikely to see the U.S. significantly decrease its reliance on petroleum in the immediate future, Steffens also added, as renewables are still a long way off in replacing our oil needs, despite political and environmentalist ambitions.
For example, it takes a lot of oil to build and install windmills. One report Steffens read recently stated that to replace coal-fired power plants with windmills would take 37 percent of the United States’ landmass surface covered with windmills and solar panels, which is untenable.
If political pressure mounts and fracking is curtailed, we could also see a price spike, Steffens noted, as this is where new production is coming from.
“Conventional discoveries are way down,” Steffens said. “They’re at an all-time low over the 3-year period because of a lack of investment in offshore drilling and frontier exploration drilling. … If you drilled a horizontal well 2 miles long through a shale formation and did not frack it, you’d get nothing. The well would never pay out. It probably wouldn’t even produce 50 barrels a day and would never pay out. So all exploration and development of the shale plays would stop immediately if you ban fracking. And of course that would be just like all of Saudi oil being taken off the market. You’d have oil go to $150 bucks a barrel tomorrow.”
If we don’t have a shock or a forced political error in the energy space, however, we should be OK, Steffens noted. Oil averaged $56 a barrel in the third quarter. He doesn’t worry too much about the short-term movement and the oil price. Some players in the sector are also paying nice dividends right now, he noted, which makes it attractive to investors looking for dividend-paying stocks right now.
Article written by Ethan D. Mizer