Crude oil tried to rally a couple of weeks ago after an OPEC member stated a willingness to cap production. Speculation about production cuts sent prices even higher, but then reality started to take hold. Some hope was reignited when the International Energy Agency (“IEA”) issued a report forecasting that oil markets would start to stabilize next year. The IEA’s assessment was based on production declines, industry capital expenditure cutbacks, and a drop in U.S. shale-oil production.
This morning’s headlines told a different story. Saudi Arabia’s oil minister unequivocally said that a production cut “was not going to happen.” Furthermore, there is a lack of trust among OPEC members, and he is not convinced any country would deliver on a promise to reduce output. Instead, freezing production and letting demand catch up is the easier solution in his view. However, even that requires every country to keep its promise, which is a scenario that cannot realistically be monitored.
As a result, crude-oil prices have declined about 7% this week and are trading around $31 per barrel today. This is a small improvement from the sub-$30 prices earlier this year, but far from the $50 level that analysts believe is necessary to spur new investment. Although low energy prices are a boon to consumers, the stock market and various economic segments are now reacting negatively.
Historically, there have been many periods when the stock market and energy costs were negatively correlated—stock prices were hurt by rising oil prices. Over the past three months, the opposite has been true, with an 83% positive correlation between moves in crude oil and the S&P 500. In other words, there is a very high probability that you can determine the directional move of stocks on any given day by what is happening to oil prices.
Utilities is the top-ranked sector and the top-ranked overall equity category for the seventh week. Its relatively high yield and low correlation to economic activity makes it attractive during times of market turmoil. The market’s current desire for defensive holdings is also evident with Telecom and Consumer Staples holding the second and third spots for fifth week. After four weeks of these three categories being the only ones in the green, today they are joined by Industrials. Granted, no green pixels are actually visible on the chart, but mathematically, the momentum reading for Industrials is now on the plus side of zero. The market rally of the past week improved every sector, although seven still remain in negative trends. Real Estate and Consumer Discretionary saw the largest improvements, with Real Estate moving one notch higher and Consumer Discretionary climbing three. Materials, Technology, and Health Care all moved lower. Energy successfully moved out of the basement three weeks ago but hasn’t made any progress since then. Financials is at the bottom.
The across-the-board improvement is impressive with the average style category seeing a 20-point improvement in its momentum score over the past week. Similar to the sector rankings, the style lineup indicates a strong investor preference for defensive market segments. For styles, defensive typically translates to “the bigger the better.” The top-six categories are in the same order as last week, headed up by Mega-Cap with the three Large-Cap categories next. There was minor shuffling among the lower-ranked categories, resulting in a lineup that is more capitalization-oriented than a week ago. Mid-Cap Growth moved ahead of Small-Cap Value, and Micro-Cap fell below Small-Cap Growth to land on the bottom.
All global categories have been in the red for eight solid weeks. A few are getting close to crossing over, but it hasn’t happened yet. Today’s market action suggests it may take a while longer. The two resource-rich categories of Canada and Pacific ex-Japan remain at the top. This would appear to conflict with the below-average rankings of the Materials and Energy sector. However, most of this strength can be explained by the recent 5.7% gain of the Canadian dollar, the 5.2% advance of the Australian dollar, and the 16.6% surge in gold prices. Latin America posted the best improvement of the week, jumping from seventh to third. EAFE was the only other category to move higher, climbing one spot. The strength of Latin America and EAFE pushed the U.S., Emerging Markets, World Equity, and the U.K. all lower. The bottom three remain the same, although Japan is now in jeopardy of falling to last place.
“ The idea of cutting production is never going to work in the near future.
In order for a cut to work, you need to be able to effectively monitor each other. ”
— Omar Al-Ubaydli, senior research fellow at the Mercatus Center of George Mason University
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