05/23/12   Who Doesn’t Like Watching Oil Prices Drop?

Editor’s Corner

Investor Heat Map: 5/23/12Who Doesn’t Like Watching Oil Prices Drop?

Ron Rowland

Among many notable moves in financial markets this week, we find the action in crude oil particularly interesting.  Futures fell below $90 in New York trading for the first time since November.  Bad news for the oil companies and good news for consumers, right?  Maybe. The reasons behind the move are not necessarily encouraging.

Basic supply/demand factors are the place to begin.  Crude oil inventories are high while demand is weak.  Electric utilities increasingly rely on natural gas, so summer usage may not match historical patterns.

Iran is a wild card for oil prices.  New talks suggest Persian Gulf tensions may ease, at least temporarily.  The prospect seems to already be removing much of the geopolitical “risk premium” from oil prices.

Finally, oil prices reflect declining global growth forecasts.  The entire developed world is still struggling to avoid outright recession; Europe seems likely to drop below the line within months.  Today’s EU summit meeting is unlikely to help.

Central banks now have far less room to maneuver than when recession struck four years ago.  Massive stimulus by the Federal Reserve and others seems unlikely to continue.  Traders now realize “Operation Twist” will expire on schedule next month.  The economy is on its own in a way most investors have never seen.  Deleveraging in the private sector will also accelerate.

Bond markets seem conflicted about all this information.  Treasury Inflation Protected Securities, or TIPS, sold at a negative yield in last week’s auction. That means investors are, in effect, paying the government for inflation-matched returns.  Even the standard ten-year bonds fetched strong demand at rates as low as 1.71% today.  At this level, buyers holding to maturity have little prospect for an after-tax inflation-adjusted gain.  And they’re okay with it.

In this environment, perhaps the only surprise is that stocks haven’t fallen even further.  The U.S. has so far managed to hold up better than the rest of the world, and it may continue doing so.  In a world where break-even is considered victory, we wonder how long it can last.

Sectors

Market conditions have turned defensive, and our sector rankings reflect it.  The Utilities group still leads the list and again had the week’s top performance.  #2 Consumer Staples is the only other category with a positive momentum score.  Health Care slipped to third with slightly negative momentum.  Fourth-place Telecom joins the “defensive” group for now.  Below this the numbers worsen quickly.  Consumer Discretionary – which topped the chart only two weeks ago – is now in fifth place.  Industrials and Technology are again roughly tied.  The JPMorgan Chase (JPM) worries pushed Financials down to eighth place.  The Materials sector fell hard but was already ranked ninth out of ten.  Energy, despite outperforming most other sectors last week, is still in last place.  It seems likely to remain there absent a sharp crude oil rally.

Styles

The Style category momentum readings are roughly twice as bad as they were last week.  Hence the spread between #1 Mega Cap and last-place Small Cap Growth also doubled.  The chart shows near-perfect capitalization alignment.  The four largest-cap groups are on top while the four smallest are on the bottom.  The Micro Cap benchmark, slightly ahead of all three Small Cap categories, is an exception to the rule for now.  Long-term trend indicators look better for the larger-cap groups.

Global

The U.S. is simultaneously sinking and floating.  How?  Momentum and absolute strength fell since last week, but domestic stocks still enjoy world-beating relative strength.  The World Equity category moved up to second, displacing the U.K.  Declines in the British Pound magnified the drop in stock prices there, and the category fell to third place.  Japan, for all its woes, moved up to #4.  Stocks there are slightly less ugly than those of the lower-ranked regions.  The middle of the pack consists of three developed market categories: Pacific ex-Japan, EAFE, and Canada.  Europe moved up the ladder and is now ahead of the three Emerging Market categories.  China fell hard, but Latin America is still the worst major region. Last November’s low is now a distant memory for the whole continent, though Brazil is ground zero for most of the damage.

 

Note:

The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.

 


 “I wouldn’t pick a bottom for the market.”

Tim Evans, energy analyst, 5/23/12


 

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