Markets Sliding on Oil Prices
Oil topped $55 once again on Tuesday and the equity markets lost traction after two days of gains. Various commentators on oil suggested $60 is not far away with warnings about $80-$100 possible if terrorists interrupt the flow in Saudi Arabia. Where have you heard this before? Investors worldwide are just now being exposed to what we have been discussing for the last nine months and the news is not being digested well.
Dow Chart - Daily
Nasdaq Chart - Daily
The economic calendar was very light today with only the weekly Chain Store Sales to attract investor attention. Sales for the week fell -0.4% from last weeks +1.5% gain but in reality nobody was watching. Oil was the major economic stumbling block with an opening sprint higher to $55.15 and only 50 cents below its all time high of $55.65 set last quarter. The return to the highs spoiled the positive sentiment for equities that took the Dow and S&P to three-year highs on Monday. The post Jobs Report spike faded and the markets closed at their lows for the day.
The end of day weakness was punctuated by a rumor of a large explosion in NYC that ultimately proved false. The markets closed at their lows for the second straight day and the major indexes closed just above their closing support for Friday. We are right back at the pivot point where the direction must be confirmed or risk a retracement of Friday's gains.
Oil prices may have weighed on equity prices but in reality it was probably a fear of Intel that caused the most weakness. On Monday TXN warned that lower than expected demand would pressure profits for the first quarter. TXN fell a buck on the news but the real damage came from fear that Intel will also lower estimates on Thursday. XLNX was also slated to issue their update after the close and that weighed on investor sentiment after the TXN warning. XLNX did announce after the close and they raised revenue guidance to +5% to +8% and well above their prior +1% to +5% guidance. Margins would remain in the 62% range on the higher numbers. The ALTR update is tomorrow and INTC update is Thursday. With TXN guiding lower and XLNX guiding higher the semiconductor sector has got to be confused on Wednesday. The SOX made a lower high on Monday at 445 and threatened to break support at 433 on Tuesday. The XLNX update could help maintain that support as we await Intel.
SOX Chart - Daily
Crude Oil Chart - Daily
Probably the most talked about story was the price of oil with it edging back over $55. The "experts" are out in force with differing views of the future. Those suggesting much lower prices ahead are beginning to fade with the EIA making headlines today that gas prices would probably set new record highs soon. The current average high is $2.15 and the EIA said this could be broken this spring. In some areas it is already over that level but the official national average is still hovering around $2.00. The oil companies have not added any refining capacity in the U.S. in the last 15 years and there are no plans on adding any with oil production volumes headed down soon. Despite being flush with cash, XOM has $28 billion, there is simply no incentive to invest a billion or more to expand current refining operations when the outlook is grim. Outside experts can say what they want about the future of oil production but the real proof is watching how oil companies spend their money. Nobody is investing in new refineries to process incoming oil. Ironically Venezuela is one of the biggest U.S. refiners. Citgo service stations, 14,000 of them, are owned by Petroleos de Venezuela and they sell a little more than 1.0 million barrels of oil per day that is refined into gas by Citgo's own refineries. The president of Venezuela, Hugo Chavez, is contemplating selling the chain to convert assets not under his control back into cash.
On a side note Chavez is also threatening to cancel/modify contracts with XOM, COP, APC and HNR to require higher payments to the government for any oil produced from his country. Venezuela production is already lagging despite having extra oil available. It is one of the few countries with untapped reserves but the political instability is preventing them from being extracted. The same is true in Russia where production is slowing from a breakdown in investment in the oil sector due to political insecurity. OPEC meets next week and all signs point to no increase in production quotas despite the high price of oil. In the past OPEC has resisted high prices as stimulative to global exploration and a potential weakening to their monopolistic position. With no attempt to increase production at the current levels it suggests to me they realize there are not any material undiscovered deposits and they are no longer in danger of being diluted. Secondly, world equity markets are doing fine in the face of high oil so why would they want to cheat themselves out of the higher revenue? We will get the oil inventory levels tomorrow morning and will probably see some strong price volatility regardless of the levels. The sudden late season snowstorm across much of the U.S. also should pressure prices as more oil is consumed as heating oil and depleting supplies ahead of the switchover to gasoline production just ahead.
Also pressuring equity prices today were conflicting comments from Fed officials and a weak dollar. Fears of higher rates overseas sent the Euro higher and the dollar lower. Fed head Poole said the measured pace language would have to be removed sooner or later to allow the Fed to react to inflationary pressures. Bernanke fired back that the measured pace moves should persist. He also said that although the measured pace language would be eventually have to be removed the neutral level for rates might be lower than in the past. All this political rate positioning is occurring in preparation for the March 22nd Fed meeting where some have said that language would be removed. I don't believe the equity markets really care what happens at the meeting because they are resigned to a 3.5% Fed rate by year-end. A 25-point hike is already priced into the March meeting and the Fed funds futures are pricing in a 37% chance of a 50-point hike. The May and July contracts are already calling for a full +25 points each and a minimum rate of 3.25% by the third quarter. Bonds were weak on the strong economic outlook by all three Fed heads at the podium today and the $24 billion in new issues hitting the market on Wed/Thr. The CRB Index made a fresh 24-year high as oil and copper continued their gains. If the Beige book out on Wednesday suggests inflation is still tame and the economy is growing then Fed worries could be lessened. Bernanke said he expected GDP growth for the year at +3.75% and he is actually on the light side of recent forecasts.
Copper hit a new high at $1.52 today and market wisdom suggests that as long as copper continues higher so will the market. Bull markets are said to have a copper roof as strong economic conditions push copper higher and equity markets follow. Once copper ceases its climb it suggests demand is slowing and bull markets tend to fade when that copper top is reached. So far the trend is intact and I will continue to monitor it in future commentaries.
Commodity Index Chart - Daily
Copper Chart - Daily
If you are looking for an entry in the homebuilders this might be your week. Ryland warned yesterday that earnings would be pressured by delayed closings caused by bad weather in several markets. The closings would be pushed into the next quarter and they reaffirmed their earnings outlook for the year. However, traders used the warning as an excuse to take profits and while the drop was steep it failed to break support from last week. Also, remember that TOL and PHM just raised guidance over the last two weeks so the problem may be specific to Ryland. KBH -3.66, RYL -4.27, TOL -3.25, PHM -1.06, NVR -11.50.
I mentioned shorting MSO last week, as Martha was about to end her prison stay. I wish I had taken my own advice now that MSO has fallen to $25.92 from Friday's high of $37.06. This was a pure sell the news event after the stock rose from $10 to $37 while she was in jail. Now that she is out the buzz has faded and along with it the stock price. I also suggested shorting AAPL in the Leaps section two weeks ago at $44.50 in anticipation of a post split depression drop. The stock had simply gone too far too fast and the Ipod copycats are coming out of the woodwork almost daily. AAPL closed at $40.53 today and my target was $35.
On Monday the markets rallied to three-year highs with the S&P hitting 1229, Dow 10984, Nasdaq 2100. The key level in that list was Nasdaq 2100. I have discussed this numerous times before but 2100 is still the level to watch. This has been the Nasdaq top since early January and a good opportunity for tech traders to take profits from the 2025 bounce over the last two weeks. The close took us back to 2073 and out of range for a one day rebound but still close enough to rally over 2100 if the Intel update is bullish. We are still a little more than a week away from the normal start of the warnings cycle for Q1 and can still go in either direction. There is nothing that says the broader markets can't move higher without techs coming along for a ride but it generally does not happen that way. The Nasdaq is still fighting the 50-day average at 2079 which combined with resistance at 2100 is forming a strong barrier.
The rest of the week has nothing exciting in the form of economic reports so the key for the week will be the Intel update Thursday night. With some lingering fear or maybe caution would be a better word, I don't expect many fireworks ahead of Thursday night. Ashok Kumar was on CNBC tonight and his outlook for Intel and the sector was not positive. He indicated the SOX was stuck in a range on weak demand and that outlook had not changed. He suggested Intel would not surprise in either direction and it would be a lukewarm report. This sets up Friday as the potential day for a move but without any material catalyst the incentive to break 2100 may be missing.
Exxon will host their analyst meeting tomorrow and while I do not expect any surprises you never know in the current high oil environment. A comment about slowing discoveries or declining production could push prices sharply higher but Exxon does not normally rock the boat. They prefer instead to just sit back and accumulate the cash from higher prices and not become a victim of the kill the messenger crowd. I have no recommendation for the rest of the week. The Nasdaq failed at 2100 as expected and conventional wisdom would suggest a new cycle lower but I am not convinced it is going to happen this time. As long as the Dow stays over 10900 and the S&P over 1215 we are just one catalyst away from new highs. That puts me on the sidelines waiting for the next trend to appear before initiating any new positions.
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Today's Newsletter Notes: Market Wrap by Jim Brown, and all other plays and content by the Option Investor staff.
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