Oil Spill: Huge Crude Plunge Amid Saudi-Russia Price War Tightens Pressure on Stocks

New pressure on the stock market today from a crumbling crude market threatens to send stocks to new troughs for this downturn. Meanwhile, yields keep making fresh record lows.

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5 min read
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Key Takeaways

  • Crude plunge spills over into stock market as futures fall limit-down overnight

  • 10-year yields slide to new all-time lows below 0.4% in early going

  • Stocks on pace to make new lows for recent downturn

(Monday Market Open) Overnight, it’s gone from being a coronavirus story to a crude story as the market continues its rapid descent. 

Slammed by a 30% bloodbath in crude, S&P 500 futures sank 5% at times, hitting their overnight limit for the first time since the night Donald Trump was elected.

The limits on futures trading are arguably a good thing. It allows cooler heads to prevail, particularly in the overnight sessions. This is one rule where it’s been a long time since we have seen it, but it’s proved effective over time.

Investors facing this kind of wild trading should also try to keep cool. We said last week that volatility would continue until at least next week’s Fed meeting. There’s no change in that, and it’s not too surprising considering what we’ve been through. Anyone thinking of trading today or this week should consider not going “all in” or “all out,” and keeping trade sizes smaller than usual.

With the main daily session underway, a drop of 7% in the S&P 500 Index (SPX) would trigger a 15-minute trading pause.

There’s no pause in the Treasury yield collapse that began two weeks ago. The 10-year yield dropped below 0.4% early Monday. Investors continue to price in odds of another Fed rate cut as next week’s Fed meeting approaches.

As all this happened, the Fed announced Monday it would step up liquidity actions to guard against market pressure, the media reported. More details on that could be coming, but the basic idea seems to be that the Fed’s regional banks will increase the amount of money they offer banks for short-term needs, something that started last fall when short-term funds got tight.

U.S. crude futures fell to four-year lows below $30 a barrel at times early Monday, putting new pressure on a stock market already down double-digits thanks to the coronavirus. Over the weekend, Saudi Arabia announced lower prices on crude it sells to foreign buyers, and now seems ready to begin raising production well above current levels, oil market watchers said. This came after OPEC and Russia couldn’t agree on further production cuts last week.

It sounds like Saudi Arabia might be trying to crank up the pain on Russia now that Russia has declined to reduce production further. The Saudis can make profit on crude at much lower prices than Russia can, so in this scenario it’s possible Russia would suffer most. U.S. drillers are also likely to feel the heat, which could lead to more pain for that industry.

Crude Correlation to Stocks Back in Play

The question is whether crude can hold psychological support at slightly above $30 a barrel. If it can’t, the long-term February 2016 low of $26 might be threatened. Crude was near $32 as the opening bell approached.

When you think back to the tepid stock market of early 2016, one of the big trends then was the close correlation of crude prices to stock prices. The same thing might be happening again here, analysts said, with stocks struggling to get a bid as the crude market sends signals of weak business and consumer demand as well as chances of major trouble for the Energy industry. Anything like that could hurt the U.S. economy and jobs, especially in states where oil is a big business.

The Energy sector fell at times Friday to levels not seen since the 2009 stock market bottom. The SPX has more than quadrupled from its March 2009 low (today’s the 11th anniversary of that), but the Energy sector has gone nowhere since then, with all gains from that point now gone.

If there’s a silver lining, sliding crude prices could give consumers a break and provide some economic stimulus. Pump prices fell below $1.50 a gallon in parts of Texas over the weekend and even dropped below $2 in far northern Illinois, not a state usually known for cheap gas.

Lower oil costs could also lend the sputtering transport sector a new spark, as airlines, trucking companies and railroads now can buy their energy supplies at rock bottom prices. It wouldn’t be surprising to see some companies—especially airlines—use this as a major hedging opportunity. That would be in line with what many of them did in 2016 and 2009 during previous oil market crashes, and ultimately it could provide a nice tailwind for their earnings in coming quarters assuming the economy gets past this current breakdown.

However, it’s unclear how quickly airlines might jump in to hedge crude costs in a climate where many travelers are canceling trips due to the virus and as the Boeing (BA) 737 MAX issue drags on. All this means crude might not get an immediate demand boost the way it sometimes has in the recent past when it cratered.

As crude falls off the proverbial cliff, natural gas futures have a chance to make what could be a generational kind of low. They were holding at around $1.66/MMBtu (million British Thermal Units) as of Sunday night. The 2016 low was $1.611. Below that, you have to go back to late 1998 to find a weaker price for the front-month contract at $1.61, and the last time it traded below $1.61 was in 1995.

Retail Response

Retail investors appear to be caught off-guard by the severity of the pullback in the U.S. stock market and aren’t using this perhaps as a big opportunity to “buy the dip” as maybe we have seen in the past.

Those who are buying seem to be focusing on either names like Apple (AAPL) and Microsoft (MSFT) that people trust for a longer term or in the Costcos (COST), Cloroxes (CLX) of the world that may benefit in this type of environment.

It is technically disappointing that the market sold off each of the days after two historic rallies last week where the SPX gained 4.6% and 4.2%, respectively. That’s not necessarily a positive sign, and reinforces ideas that rallies might continue getting sold as long as Treasury yields remain in the dumps.

From a sector perspective, Utilities and Healthcare led the charge last week, while Energy and Financials finished last on the leaderboard.

Taking a Ride on the Transports

Transports—often seen as an economic barometer—probably bear watching this week as we hear more about the cruise line and airline industry’s struggles. The Dow Jones Transportation Average ($DJT) dropped 4.6% last week and is in bear market territory (down more than 20% from highs). Small-cap stocks got outpaced by their larger cousins, too, in the week that just finished, falling 1.8% as the SPX and the Dow Jones Industrial Average ($DJI) eked out small gains.

Transports and small-cap companies might depend more than some other industries on how consumers react to the virus scare. For the moment, anecdotal evidence sees restaurants remaining crowded. A White House economic advisor went on TV Friday to encourage people to keep going to work and not let the virus change their lifestyle. As the month goes by, we’ll see if people follow that advice from Washington (see more below).

This week’s data include consumer and producer prices for February on Wednesday and Thursday, respectively. Michigan sentiment for early March on Friday might stand out more than usual as investors try to get a sense of whether the virus is starting to have an impact on consumers. There’s no really important data due today.

CHART OF THE DAY: TRANSPORTS HANGING ON TO SUPPORT? Going back to 2016, the 8800 level  acted as a strong support (yellow horizontal line) for the Dow Jones Transportation Average ($DJT–candlestick). With $DJT close to 8950, it’ll be interesting to see how well it holds to the 8800 support. The index struggled to break above 8800 from the end of 2015 to mid-2015. It finally broke above it in November 2016 and managed to hold above that level pretty well. Will it stay above 8800 or break below it to test the 2016 lows? Data source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.  

Looking Forward: Friday’s selloff following a solid jobs report shouldn’t have come as much surprise if you have a sense of how the market works, particularly in volatile times like these. Jobs data, by its very nature, is backward looking, and the stock and bond markets look ahead. For now, the data haven’t caught up yet with expectations for a slowing economy, but the stocks and bonds tell you what investors expect. At this juncture, they’re repricing assets to get out in front of the virus impact on the economy. That’s why looking at more timely statistics like weekly job claims and crude inventories and production might be a better way to monitor things in more of a real-time manner. The other thing to remember is that once the stock and bond markets turn around—and there’s never been a past correction when they didn’t eventually—it’s likely going to happen before the data start to improve much. 

Did Fed Help Friday’s Comeback? Why did stocks bounce so much from lows in the last half hour Friday? Short-covering seemed like a factor in those final minutes, but some market participants said comments from a Fed speaker late in the day might have also contributed. Boston Fed President Eric Rosengren said in a speech Friday that if the Fed cuts rates to near zero, “we should allow the central bank to purchase a broader range of securities or assets,” The New York Times reported. “Such a policy,” he noted, “would require a change in the Federal Reserve Act.”

Central banks in other nations can buy equities and corporate bonds, but the Fed is legally limited to government-backed debt, like mortgage-backed securities and Treasury notes. Buying other asset classes would require opening legislation that empowers the Fed, The New York Times reported. It seems pretty far-fetched to consider the Fed stepping in to buy equities, but maybe thoughts of the Fed taking some sort of drastic measure raised optimism in the market late Friday. For now, this is just speculation, not something anyone should consider trading on.

One More Lap Around the Jobs Report: Glancing back once more at Friday’s impressive jobs report, let’s break down where the gains and losses happened. Leading categories included health care and social assistance, food services and drinking places, government, and constructions. All of these saw very healthy gains, with 42,000 new construction jobs standing out.  A warm winter might have pulled a lot of construction jobs forward into January and February. With that in mind, remember that the March and April reports might not get the usual lift from construction because part of it already happened. Government jobs also might be a blip this year due to one-time demand for people to conduct the census. 

With the virus in mind, consider keeping a close eye on the health care and food services sectors when next month’s report comes out. February’s report probably didn’t pick up much virus impact on either of these, but it wouldn’t be surprising to see food and drinking establishments lose ground, and health positions gain ground, if the virus starts having a real impact on people.

 Good Trading,

JJ

@TDAJJKinahan

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This week's economic calendar. Source: Briefing.com
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Key Takeaways

  • Crude plunge spills over into stock market as futures fall limit-down overnight

  • 10-year yields slide to new all-time lows below 0.4% in early going

  • Stocks on pace to make new lows for recent downturn

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