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Can the Markets Find Some Oomph? Low Oil Prices Hold Stocks in Check Again

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August 2, 2016

(Tuesday Market Open) Stocks looked to be taking another turn to the downside early today as crude prices straddled both sides of $40 a barrel and investors kept close watch on European and Japanese stocks.

In Europe, investors worried about the banking sector, which sank again today after grim results from the European Banking Authority’s stress tests, announced Monday. Meanwhile, a new fiscal package aimed at providing oomph to sagging economic growth and inflation was unveiled in Japan. Will this one work?  

Stocks trading on the Dow Jones Industrials (DJIA) and the S&P 500 (SPX) edged higher at the open Monday but settled moderately lower as crude oil prices made good on Friday’s threat to unwind markets as they tumbled below $40 a barrel. That’s the first time in three months that oil fell below $40 and analysts now are looking at a support level of $36 a barrel. West Texas Intermediate (WTI) settled just a hair above $40 at $40.08, its lowest place since April 20. In the early going, oil prices look to be searching for higher ground, but the gains are minimal.  

Why is this happening? Pure and simple economics of supply and demand. Consumers put on lots of vacation mileage so far this summer, but they haven’t been enough to offset the glut in oil supplies, analysts say. In early June, oil prices appeared as if they would hover comfortably in the $50 a barrel level as analysts anticipated a summer full of gas-guzzling road trips. Though supplies are well off their highs of June 2015, they are still far above historical averages, according to the Department of Energy. Monday’s crude close translates to a 21.8% pullback in prices since hitting $51.23 a barrel in early June. That put oil into bear-market territory, which is defined as a falloff of at least 20% from recent highs.   

Consumers’ wallets are fatter with the drops, which are translating to lower prices to fill tanks for cars, SUVs and trucks. That’s already being seen in consumer spending, which has been relatively robust and was the only highlight of last week’s GDP numbers. The national average of regular gasoline costs sits at $2.13 a gallon, according to AAA.com. A year ago, prices were at $2.65 a gallon. Some analysts are projecting that prices at the pump could slide to $2 by Labor Day and as low as $1.50 by Christmas.

“With gasoline supplies high and oil prices low, pump prices are likely to remain relatively cheap through the remainder of the summer and into the fall,” AAA says. “While a record number of American motorists have hit the road for summer travel, sharply lower gas prices have not triggered the sharply higher gasoline demand that many analysts had anticipated.

“This was evident in last week’s Energy Information Administration report, which revised the mark for U.S. gasoline demand in May lower by 213,000 barrels per day to 9.436 million,” Here’s the catch on that statement: The demand number was still the highest total on record for the month of May.

The stock market is not correlating perfectly with oil costs, but Monday’s downturn could set that pattern of the two running parallel again. Will it hold? The Dow finished the session at 18,404.57, off 27.73, or 0.15%. That represented a 63-point swing from its intraday high. SPX settled at 2,170.84, off only 2.76 points, or 0.13%.

The Nasdaq Composite Index (COMP6) bucked the trend, finding higher ground at 5,184.20 at the close, up 22.07, or 0.43%, as it climbs back toward its all-time peak reached two weeks ago.

Monday’s trading, marked also by weak manufacturing production numbers, may also be seen as another repercussion of the Commerce Department’s gloomy GDP estimate of 1.2% for Q2, released Friday. That was nowhere near the consensus of 2.6%, but it’s not Commerce’s final number either. Yet, the drop in the ISM index to 52.6 in July from 53.2 in June, paints an economy marred by pockets of weakness. 

What may make a difference to the markets is today’s personal consumption expenditures (see below), which the Federal Reserve closely watches. Of course, Friday’s jobs numbers are a must-see as well. 

S&P 500

FIGURE 1: TIGHT TRADING.

The S&P 500 (SPX), plotted through Monday's close on the TD Ameritrade thinkorswim platform, has been trading in a tight 10-point trading range since mid July. Can it break out? Data source: Standard & Poor’s. For illustrative purposes only. Past performance does not guarantee future results.

We’re Spending More. Yep, that’s what the Commerce Department is seeing, according to June’s numbers, released earlier today. Consumer spending climbed 0.4% in June, following a similar path in May. That was better than most economists had expected, which was for a 0.3% gain in spending. Some of that was already apparent in last week’s GDP results, which showed that consumer spending is rising at an annualized rate of 4.2%, the fastest in nearly two years, according to reports. And as many traders might remember, that was the brightest spot in an otherwise somber GDP report. Is that level of Q2 spending sustainable?

Brace Yourselves Dear Traders. When they talked about the “dog days of summer,” they (whomever “they” are) may as well have been referring to what has historically been the most difficult three months of trading as volatility typically rules the doghouse through October. Monday kicked that off and the market’s performance did nothing to help rewrite history. But one day does not a three-month stretch make. And with volatility, as measured by the so-called fear index also known as the VIX, at levels not seen in two years—it climbed nearly 5% Monday but is still quite low at 12.44—many analysts say they are waiting it out.

S&P Global points out that the S&P (SPX) has advanced some 19% since the Feb. 11 routing and that if it’s in need of a “digestive decline,” now is as good a time as any, historically speaking. “August and September are ranked 11 and 12 in terms of monthly price increases since WWII,” S&P Global’s Sam Stovall says. “They recorded the second and third deepest single-month declines, and are in the top one-third of monthly volatility.”

There’s more: “Also, the S&P 500 recorded one-third of all monthly declines of 5% or more in August and September,” he adds. “Finally, the S&P 500 fell in price an average of nearly 1% during Q3 since 1990, while seven out of its 10 sectors also recorded average price declines. Forewarned is forearmed.”

Hey, What’s Up with Interest Rates? If you asked some Federal Reserve members, the message to traders after last week’s no-rate-hike decision is not to get too smug about ruling out an increase yet this year. Federal Reserve Bank of New York President William Dudley, speaking in Bali over the weekend, said that the path the Fed was on to raise rates has changed over the last year. But, as the Fed noted last week, a rate change yet this year is still on the table. “The risks to growth from Brexit and other international developments could fade away,” Dudley said. “If such events were to occur, this might necessitate an even faster pace of adjustment," he said. "It's premature to rule out further monetary policy tightening this year. It depends on the data, broadly defined, and as we all know, that's not something one can predict with any great accuracy," he said. Tell that to traders, the majority of whom are not expecting an increase now until May. Yes, May, according to the CME’s FedWatch Tool of the 30-day Fed fund futures prices, which shows a 51% probability then. 

Good Trading,

JJ

@TDAJJKinahan

Economic Report Calendar

FIGURE 2: THIS WEEK'S ECONOMIC REPORT CALENDAR

Source: Briefing.com

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JJ Kinahan

JJ began his career in 1985 as a Chicago Board Options Exchange...

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