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Index Wrap

A real head scratcher

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Oil prices rebounded sharply with November Crude Oil futures (cl04x) $54.92 +3.05% settling just a penny below their October 15 record high, while money flowed into Treasuries with the benchmark 10-year yield ($TNX.X) falling 4.9 basis points to 3.991% as traders contemplated the taxing effect energy prices might have on the economy and corporate earnings.

Markets looked weak as the Dow blue chips approached their August 13th intra-day low of 9,784, but financials firmed, while energy and technology shares provided a lift to have the major indices finishing mixed at the close.

While weekly crude oil inventories showed builds (+1.2MB vs. consensus +2.0MB), it was a fifth-straight decline in distillates (-1.9MB vs. consensus -1.0MB) with winter fast approaching that sent crude oil back near contract highs as all major energy complexes found notable gains.

For tonight's Index Trader Wrap, I wanted to quickly look at crude oil, heating oil, unleaded gas and natural gas futures contracts, to gain a quick perspective of what traders, not just energy, might want to be alert to.

Energy futures - 10/20/04 Close

I'm not an oil refining expert, but most report have refiners here in the U.S. running at about 90% capacity, and while industry will say that refiners can turn out heating oil like candy, compared to the extra refining it takes to produce gasoline for our cars, the continued decline in HEATING OIL inventories is what traders have been focusing on, with the thought being that as refiners start to switch some of their refining capacity to heating oil, the demand for oil could build further depending on how cold this winter is.

What I've done this afternoon was looked at Dorsey/Wright and Associates' point and figure charts of the various energy futures contracts shown above, and quickly jotted down the vertical counts (bullish = green text ; bearish red text; blue = where current bearish vertical count would be negated).

While bullish and bearish vertical counts can be met, exceeded, or sometimes never met, I would eyeball crude oil potentially rising to at least $58 (Jan-March bullish counts).

Heating oil seems to be the driver for oil prices, and here I might eyeball $1.70. Take note that the March 05 heating oil contract (ho05h) $1.468 +3.19% has already exceeded its bullish vertical count. Now, March can be an important month, as that is when Spring weather presents itself. We can see how the March heating oil contract does "discount" from current-month contracts.

But when refiners begin to provide greater focus toward heating oil refining, I would have to think that unleaded gasoline inventories begin seeing draws. As of tonight's close, the December, January and February contracts still have BEARISH VERTICAL COUNTS of 1.25, 1.26, 1.31 associated with their charts, but those bearish vertical counts would be negated, all three, with trades at $1.425.

Natural gas is a bit different, as it isn't derived from oil, but bullish vertical counts, along with strong industrial demand has bullish vertical counts still suggesting upside. I live in the Rocky Mountain region, where the bulk of homes are heated with natural gas. I believe my utility is currently requesting rate hike approvals, so I'll look forward to a higher utility bill than last winter (depending on weather). Where's my Farmer's Almanac?

If you can, print that little table out, as I'll probably refer back to it in the future, and give periodic updates.

Bottom line: Energy prices most likely either dampen economic growth, pressure corporate earnings, or investor optimism.

While energy prices found renewed gains after taking a couple of days rest, Treasuries found what I would have to consider DEFENSIVE buying.

Now, before I go running off "half cocked" and start screaming deflation/stagflation, I have to remember that in May, I wasn't overly certain that the bond market was signaling INFLATION.

In fact, I thought the selling in Treasuries was OVERDONE and YIELDS would fall back to a more gradual trend.

On September 23, roughly 3 weeks ago, I profiled a BEARISH trade in Treasuries, with a PUT OPTION play in the Lehman 1-3 year iShares (AMEX:SHY) $82.16 +0.08% at the $82.06 price level.

Since we monitor the 10-year YIELD ($TNX.X) in the pivot matrix and the intra-day Market/Snapshot Internals, I want to show the WEEKLY bar chart of the 10-year YIELD ($TNX.X), so we get perspective on why I think we're at a rather meaningful level of yield support, where if broken, considering the higher price of energy, could draw a further negative reaction from equities.

Conversely, a GRADUAL raise in YIELD could be beneficial if the MARKET feels that the economy is growing fast enough, to offset the higher energy prices.

Lets face it. Energy prices aren't rising because the global, or U.S. economy isn't demanding it.

10-year Treasury YIELD Chart - Weekly Intervals

While it may be beneficial to the economy that Treasury YIELDs have fallen (in the form of lower borrowing rates for consumers) I must now place close attention that while my analysis that YIELD would fall as INFLATION was not likely does have yield back lower, the 10-year YIELD is right back where it was just over three weeks ago. The above chart was constructed with two (blue and pink) conventional uses of retracement.

PIVOT MATRIX traders will note the OVERLAPPING 39.89-39.84 levels. I think we can see how the yellow "zones" have provided some area of congestion in recent months, where breaks of these yellow zones then found a further directional trade.

A primary thought that I would have is that a potentially BEARISH scenario for equities would be further gains in energy price, and lower Treasury YIELD, where the decline in YIELD would be a DEFENSIVE posture from the market.

Now, I do struggle with this "lower YIELD" a bit. After all, a lower YIELD is rather beneficial to the consumer in the form of borrowing rates of interest. But, at this point of the economic cycle, where I've been looking for a resumption of economic strength, the lower YIELD found in Treasuries does begin to concern me.

The "fly in the ointment" to my longer-term bullish bias on the economy, is that I did not consider that oil/energy would have risen like it has. There may be other market analysts that are also dealing with the energy variable.

U.S. Market Watch - 10/21/04 Close

Tonight I'm showing the last 20-day's POINT gains/losses, not percentages as I will do from time to time.

Let's say the Wilshire 5000 ($DWC.X) comprises both the NYSE and NASDAQ. Over the last three weeks, its down just 13 points at today's close.

We can see the DIVERGENCE between the INDU/SPX/OEX and the COMPX and NDX.

Why is this? I would think largely due to what has taken place in just the last 5 days for both the IUX.X and HMO.X. Is what has taken place in the IUX.X and HMO.X a MARKET call on the economy? I think not. Time will tell if there is any economic impact, but I would have to believe that it is the uncertainty surrounding any litigation, and perhaps future earnings rates of growth, should we see new regulations placed on the industry.

Most of the insurance and health insurers are listed on the NYSE. Without having tried to factor in weightings, etc., I'd be willing to bet that if I removed both of the losses from the IUX and HMO indices, the recent three-weeks changes for both majors (excluding the very narrow Dow Industrials) would be equivalent.

If so, then I get the perspective that OIL/ENERGY provides the wet blanket.

What I think we need to understand, or tie together at this point is that the 10-year YIELD ($TNX.X) is at a rather important level of YIELD support (PRICE resistance) and a break much lower in YIELD will probably draw some type of EQUITY response.

The S&P 500 Index (SPX.X) also tested, briefly violated, then closed back above the 1,097-1,100 support.

Why didn't equity holders just "cave in" today? Why didn't/couldn't Treasury bulls get a YIELD close below the 3.985% level. Are stocks just "too cheap" to warrant buying a fixed income security that's only going to yield 4%?

Market Snapshot / Internals - 10/20/04 Close

Internals that look bearish to me are the NYSE and the slight stability the NASDAQ NH/NL ratio was showing a couple of sessions ago has resumed to more bearish leadership than bullish leadership.

Just prior to 11:00 AM EDT was when the 10-year YIELD hit its session low yield. While I receives several sell program premiums throughout today's session, I'm scratching my head as to why the 10-year YIELD didn't progress lower, and have equities following.

TRIN was rather "neutral" at the top of each hour, if not more bearish than bullish. I looked at the SPX options during the day, and at 12:18 PM EDT, I made not in the Market Monitor that the SPX was trading at 1,100.71 and the two most active options were the Nov. 1,100 call (5,673:14,900) and Dec. 1,100 call (5,014:46,719).

At tonight close, the most actives for today's session were the Dec. 1,100 put (9,266:64,493), Dec. 1,100 call (8,948:46:719), Nov. 1,050 put (8,840:42,539) and Nov. 1,100 call (6,471:14,900).

With the Market Volatility Index (VIX.X) 14.85 -1.85% down just fractionally, I can't make any discernable notes as to what options traders were saying, but the number of sell programs may suggest a bullish stance taken in options, which was offset by futures selling.

Pivot Matrix -

The S&P Banks Index (BIX.X) 354.69 -1.22% was notably week today, but closes right back in the "zone of support" from 352-355 (see 09/23/04 Index Trader Wrap).

The Dow Industrials (INDU) remains the weaker index, where tentative support would be found at WEEKLY S1 and DAILY S1 correlations.

In PINK, I've noted daily lows for the MAJORS, and other than the NDX/QQQ which found buyers at the WEEKLY Pivots, we did see trade below the WEEKLY S1.

Yes, the OEX did NOT trade its WEEKLY S1, but the 10-year YIELD didn't "plunge" below its WEEKLY S1 either.

Jeff Bailey

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