Crude Plunges Double-Digits

(Monday Market Open) After posting consecutive weekly gains for the first time since early February, stocks face tough skating this week if they’re going to pull off a hat trick.

Earnings and data due the next few days could remind people how badly the economy is doing and possibly cool off some of the bullish spirit that gave things a lift on Friday. That said, a trip to the penalty box isn’t pre-ordained if more good news surfaces.

Crude Reality

This morning, stocks got a visit from their old nemesis: Plunging crude prices. If you didn’t check the oil market before bed, you might have gotten a shock this morning. The front-month May contract dove more than 38% to below $12 a barrel—a 21-year low—but keep in mind that it goes off the board tomorrow and is thinly traded.

The benchmark June contract didn’t get a pass, however, recently trading down 11% at just above $22. It’s only been a week since crude got some hope from a production cut deal, but now analysts are saying even that won’t be enough to sop up billions of barrels hitting the market now and not being used.

When crude gets ripped apart like it’s been, that can make it hard for stocks to gain much traction. First of all, it puts an incredible amount of pressure on the Energy sector. It also sends a signal about anemic consumer and business demand for products in general, because crude is so integral to the overall economic picture. Maybe having the May contract expire tomorrow and June futures become the front month at such a heavy premium might remove a little pressure on stocks, but that remains to be seen.

Sail Toward the Beacons?

If the market’s had a theme lately, it’s the “beacon of light” trade. People want to see a light at the end of the tunnel and head toward it. Last week, they had several signs of that, including positive data about a potential treatment for coronavirus, President Trump talking about reopening things, and Boeing (BA) announcing plans to start production again. Anything that points at a light gives a lot of excitement, and combined, the positive news inspired a massive rally that picked up steam into Friday’s close. The week ended with stocks up 30% from their late-March lows.

The worrisome thing about chasing these beacons is if investors think the good news is a week or two away, and then it ends up being two months away. What happens to stock indices when people start getting impatient? If the mindset changes, then markets might have a longer grind ahead.

Also, when the light beacon turns to less happy news like today’s crude wipeout, it gets harder to focus on anything positive. The weak crude market isn’t distinct from the rest of what’s being traded. It plays right into things.

One bright spot early Monday included China cutting its benchmark lending rate, which appeared to give stocks a boost there. Also, back home, 10-year Treasury yields continued to cling to the 0.6% level, trading just above that this morning at 0.62%. That’s low, but we’ll see if it can hold 0.6%, which might send a positive message.

Also, It sounds like Congress is getting close this morning to a $370 billion deal to help small businesses, which would probably be cheered by investors. However, the fact that small businesses need more money so quickly might put more focus on how much this important sector is struggling, and on what plans states and the federal government have to reopen the economy. It doesn’t look like it’s going to necessarily be a smooth operation, and there could be volatility around that.

Another news item this morning was United Airlines (UAL) reporting a $2.1 billion Q1 loss and saying it needs more government loans. Oil field services company Halliburton (HAL) had better than expected earnings but warned about impact from coronavirus-related demand pressure. The stock recently climbed double-digits in pre-market trading.

Brace Yourself for a Tough Calendar

Earnings this week might bring home just how poorly things are going in the economy despite these recent beacons. Prepare for possible stomach-churning results from airlines, including Delta (DAL), Southwest (LUV) later this week.

Data in the days ahead include existing and new home sales, April sentiment, and durable goods. It’s hard to see any of these looking too rosy. You could argue most of the bad news was baked in during the initial collapse back in March, but the market has rebounded a lot since then and some analysts say it might have gotten overdone. Lately, stocks have done a decent job of shaking off the data, so we’ll see if that continues.

Some pundits look at what’s happening and say Wall Street and Main Street are moving in different directions. There’s truth to that, and it does seem pretty incredible how quickly large-cap stocks have rebounded over the last month.

Congress is under pressure to agree on a new fiscal package to help small businesses after the first package rapidly ran out due to huge demand. Small businesses employ about 50% of the workforce, according to government data, so it’s important not to lose that in the shuffle. Large businesses won’t have people to sell their products to if small businesses evaporate.

It was good on Friday to see the Russell 2000 Index (RUT) of small caps have the best day of any major index with better than 4% gains. It had been trailing the larger-cap indices, but one day isn’t a trend. Any indication of the RUT continuing to recover could help make the argument that smaller businesses might be sharing the wealth, so to speak.

The other positive thing toward the end of last week was Information Technology behemoths like Apple (AAPL) and Microsoft (MSFT), along with some of the chipmakers, taking a back seat to some of the laggard sectors like Financials and Energy. Obviously, it would be nice if all sectors did well, but to see the most beaten-down ones find some buyers might suggest investors are finding reasons to give them another look. It also could point toward fundamentals being a little better than the initial dire predictions.

For instance, Regions Financial (RF), jumped 7% Friday despite missing analysts’ revenue and earnings estimates. The regional bank did see better than expected net interest income, an important component for bank profits, and that seemed to help the stock rally after it got slammed in March.

That said, it’s the big bruisers leading the rally over the last two weeks, and that can cause a little distortion in how we view the major indices. As The Wall Street Journal pointed out over the weekend,  the recent rally among big tech stocks underscores their hefty influence. The SPX, which is weighted by market-capitalization, is down 11% this year, while a version of the index that gives every company an equal weighting has plummeted 19%.

If you’re an investor with a broad portfolio across sectors, that could help explain why you may not be doing as well as the SPX since early April.

Turning Tables on Technicals

There’s little doubt that from a technical point of view, the market is in far better shape than it was, say, a month ago. Friday’s higher close was the first time markets have recorded gains two Fridays in a row since January (the previous week was a “synthetic” Friday that took place on a Thursday due to the holiday). In March and early April, Fridays were some of the worst days of the week as people fled long positions going into the weekend. Now they don’t seem so scared.

You could see a bit of the fear fading in bonds, too, as the 10-year yield dipped briefly below support at 0.6% last week and then clawed back to finish at 0.64%. That’s still nothing to write home about and well below recent highs.

Also, the Cboe Volatility Index (VIX) ended the week below 40 for the first time since early March. It had been above 80 about a month ago. When VIX falls, it sends a signal that people are less fearful and perhaps ready to take a more “risk-on” approach.

The strong finish Friday pushed the SPX above its 2850 support that it had dabbled with early in the day, and above the 50-day moving average that sits near 2863. That might be seen as a significant technical development, because it’s the first time since mid-February that the SPX had a close above the 50-day.

Missing the Rally: The overall market can have a great rally without any help from the Energy sector, which continues to be the worst performer of this dismal year, and also did badly in 2019 when most of the market climbed. However, it’s an old adage that it’s hard to have a big rally if banks aren’t part of it, because their status reflects so much of the economy’s general health. Financials are down around 27% year-to-date, compared with an 11% drop for the SPX.

As we noted recently, Financials have more exposure than any other sector to the shock hitting the economy, because they handle loans across all sorts of businesses big and small, as well as the consumer. Hearing from some bank executives last week, the takeaway is that there were soft Q1 results but trading businesses did well. Unfortunately, they all had to put aside big reserves to be ready for possible trouble in the near future, and that’s going to potentially hurt profitability in more than just Q1. Also, they can’t necessarily count on the financial trading business picking them up in Q2, unless market volatility starts climbing again.

Notes on the Apple Downgrade: AAPL fell Friday due partly to a Goldman Sachs (GS) downgrade, but for some perspective, remember that GS has been very tough on AAPL over the last year, even before the pandemic. GS has been concerned people might turn toward lower-priced phones, and AAPL recently said it’s begun shipping a $399 iPhone. So now the fear is lower margins.

One thing on the positive side about the downgrade is that GS doesn’t expect loyalty to AAPL products to fade, only that purchases might get put off. Some analysts differ, however, saying once this crisis ends, people might be eager to upgrade. A lot of that depends on how long the pandemic lasts and how much damage it causes the economy. People who don’t have jobs usually don’t go out and buy expensive phones.

Dipping Chips: Some of the chipmaking companies saw their stocks sag a bit Friday, but the sector has generally been on an upswing. Chip demand is likely to continue growing whatever happens in the short-term and can probably continue to do well in the long-term, though it is a very cyclical sector as far as stock performance. We’ll get some insight into the sector later this week when Texas Instruments (TXN) reports.

Speaking of dipping chips, consider grabbing a seat and tuning in tomorrow for the Netflix (NFLX) earnings report, set to be released after the close. Wall Street widely expects NFLX to turn in strong results when it lifts the screen on its quarter. However, some analysts wonder how much pricing power NFLX will hold if the economy continues to struggle.

Good Trading,


Dominik Stone

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