The Dow opened the day with a +192 point gain but it was quickly sold and the index returned to negative territory until 2:PM. The closing rally came after oil rebounded from a 12-year low at $29.93 to end the day at $30.65.
Crude oil appears to be driving the market and that is not a good sign because prices are going lower. Bond king Jeffery Gundlach helped to rally the market after he said this morning that technicals suggested a short-term bottom in the oil market. "Fundamentals are lousy but the technicals call for a short term bottom today. A short-term bottom is due today, actually." Gundlach manages $85 billion for DoubleLine Capital.
Crude flirted with $30 all morning and finally broke that $30 level at 2:PM to trade at $29.93 and a 12-year low. It was December 2003 the last time we saw oil at this level. The rebound was instant thanks to the Gundlach comments and the vast number of puts at the $30 level. Immediately traders began covering their positions with the February futures contract expiring next Wednesday.
If the markets are going to continue to follow crude prices, we are in trouble. Goldman Sachs is targeting $20 in their worst-case scenario. Morgan Stanley just revised their outlook to a $20 target. Investment bank Standard Chartered targeted $10 a barrel in their call this morning. We have not seen oil below $10 since 1998. Standard said there is no equilibrium in the market and there is no fundamental relationship currently driving the market toward that supply/demand balance.
Christine Lagarde, chief of the IMF, warned that existing supply/demand factors meant oil prices would "likely stay low for a sustained period."
OPEC responded to rumors there would be an emergency meeting to discuss production by saying the rumor was false and there would be no production meeting until the regularly scheduled meeting on June 2nd. Saudi Arabia is actually talking about increasing production because demand is expected to rise in 2016 by 1.2 million barrels per day. Instead of allowing that demand to soak up the current 1.2 mbpd of excess production and balance prices, Saudi wants to gain more market share by increasing production at lower prices.
The last time oil was under $10 in 1998 it was because of Saudi Arabia. Other OPEC nations were not sticking to their production quotas and oil prices were falling. Saudi demanded they honor the quotas but they continued overproducing. In order to punish the other OPEC members and bring them back into the fold, Saudi increased production to record levels and flooded the market with oil. They drove the price down to $10 and U.S. rig counts declined from the historic high of 4,530 to 488. For reference, the rig peak in 2014 was 1,931 and we have declined -1,267 to 664. Last week alone the rig count declined by -34 rigs.
U.S. production hit a three-month high last week at 9.212 million bpd despite the decline in rigs. The EIA said today that U.S. production was going to fall in 2016 by -720,000 bpd and more than the prior estimate for -560,000 bpd. Unfortunately, that will only make up for the addition of 500,000 bpd from Iran when sanctions are removed at the end of January.
Currently producers are in a world of trouble. With WTI crude at $30 the Bakken producers are getting only about $22 for their oil and Canadian producers are getting about $15 a barrel. The problem is a lack of available transportation and storage for oil produced from those areas.
That is far below their cost to produce and so far below they are forced to quit spending money on drilling. However, instead of drilling they are completing previously drilled wells as a way to increase production without drilling new wells. The fraclog is said to be as many as 4,000 wells across the USA. This is why production continues to increase while rig counts are crashing.
Now that the December 31st tax day for refiners has passed, we can expect to see inventories begin to rise sharply. Last year inventories rose from 382.4 million on January 2nd to 490.0 million on April 24th. That is a 108.5 million barrel increase in about 16 weeks or roughly an average gain of 6.78 million barrels per week. It would be next to impossible for a similar gain this year because of lack of storage, which is currently nearing operational capacity.
We know that refiners and speculators will want to buy every barrel of cheap oil they can find because in the long term the price will rise significantly. Refiners will fill every tank they have because it will increase their profit margins later. Analysts are projecting bankruptcies could be 25% to 35% of current producers and service companies if oil remains this low for long. That would force consolidation and would force production moratoriums because creditors would not allow these bankrupt companies to continue to drill and complete wells because that is an extreme cash burn at these prices.
Over the next three months, we can expect to see oil prices continue to decline and $25 a barrel is not unreasonable. We could see lower prices but everything depends on U.S. production rates. If there is no material decline as the EIA expects then prices could go even lower. If production suddenly begins to fall off a cliff then prices could rebound. I do not believe we are going to see a significant production drop until summer or later but I could be wrong. If crude prices continue to fall as expected the equity market is in real trouble.
The opening rally in stocks was brought to you by the lack of a material decline in the Chinese markets. They traded sideways most of the day after some volatility right at the open. We need some calm to return but the Shanghai Composite chart below suggests there is more weakness ahead. The index closed at 3,022 with the 3,000 level critical support. A break of that support could see a drop of 30% or more to 2,000.
The U.S. economics out today were not market moving reports. The NFIB Small Business Survey for December rose from 94.8 to 95.2. Most of the internal components declined with expectations for credit conditions and expansion plans weakening. The "expect economy to improve" component fell from -7 to -14 and the lowest level in more than a year. The only really positive component was the plans to increase employment, which rose from 11 to 15. That is confusing since the rest of the components were either flat or down. The report was ignored.
The Job Openings and Labor Turnover Survey (JOLTS) showed job openings rose slightly from 3.6% to a 3.7% rate. Openings increased from 5.349 million to 5.431 million. This is a seriously lagging report for the November period and was ignored.
The only highlight on tomorrow's calendar is the Fed Beige Book, which is expected to be mostly unchanged.
The earnings calendar is also weak for Wednesday. The pace picks up with Intel and JP Morgan on Thursday and many of the big banks on Friday.
S&P Capital IQ updated their earnings forecast and S&P companies are now expected to post a -5.7% decline in earnings for Q4. This would be the second consecutive quarter of earnings decline. Revenues are expected to decline -1.3% for the fourth consecutive quarter of declines. Seven of the ten S&P sector are expected to post earnings declines with only telecom, consumer discretionary and health care expected to post gains.
Intel (INTC) was upgraded by two companies today. Mizuho upgraded the company to a buy with a price target of $37. Pacific Crest upgraded to a buy with a price target of $35. Mizuho said Intel's server chips continue to dominate the cloud and the hyperscale computing sector. Also, the PC market is expected to be "less bad" in 2016. The PC market is still 60% of Intel's revenue. PC sales have been down 13% to 15% annually since 2013. In 2016, Mizuho expects only a 3-4% decline. The analyst said there were one billion installed PCs more than three years old that could be involved in a replacement cycle in 2016. They believe Intel will also benefit from new enterprise tablet chips. Intel is also expanding into industrial, medical and automotive markets. Intel reports earnings on Thursday.
Bank of America (BAC) upgraded Apple (AAPL) to a buy from neutral and a price target of $130 saying the concerns over production cuts were already priced into the stock. The bank said Apple could be poised for a bullish cycle after earnings on the 26th. Apple shares gained +$1.43 to $100 but remains well off its recent highs.
DreamWorks Animation (DWA) was upgraded by FBR from neutral to outperform because of larger than expected license payments from Netflix. DWA gave Netflix the continued global rights to its products for the current 180 countries that it now has, up from the prior 60 country distribution platform. That should produce some big checks from Netflix. The company's Kung Fu Panda series is doing great and the KFP 3 sequel is expected to be a big hit. Analysts are expecting a domestic box office of $185-$200 million. FBR put a $29 price target on DWA with the stock at $24 so it was not a big leap of faith in DWA.
Lululemon (LULU) gained +4% after raising guidance due to stronger than expected holiday sales. LULU had given cautious guidance only a month ago so business must have really improved. The company said Q4 revenue could be $690-$695 million, up from prior guidance of $670-$685 million. Earnings are now expected to be 78-80 cents and higher than the prior guidance of 75-78 cents. Analysts were expecting 77 cents on revenue of $679 million. Cowen & Co raised its price target from $52 to $66. Shares opened about 9% higher but faded into the close.
Stifel upgraded Coca-Cola to buy from hold on valuation and improving growth trends. Shares gained +50 cents.
KBW upgraded Wells Fargo (WFC) from neutral to outperform saying the recent sell off was a buying opportunity at "cheap enough" levels. Shares gained +$1.25 to %51.36.
Starbucks (SBUX) said it was planning on opening 500 new stores in China with plans to operate 3,400 there by 2019. There are currently 2,000 Starbucks stores in China. Same store sales in China rose +9% in 2015. At the end of December Starbucks had 23,043 stores in 68 countries with 14,803 company-owned and licensed stores in the America's segment. Shares rose +$1.64 on the news.
YUM Brands (YUM) also rose in afterhours after the company said same store sales grew +1% in China in December. The KFC locations in China saw an increase of 5%. Sales declined at Pizza Huts. YUM has been challenged in China from multiple food problems over the last three years. Any sales increase is positive.
United Continental (UAL) said passenger revenue would be lower than expected because of the terror attacks in Europe and the lack of oil executive travel to and from Houston. Low oil prices should have been a boost for United but in this case, the company said lower energy executive travel all over the world is reducing traffic. Shares are approaching a 52-week low under $50.
After the bell, Met Life (MET) said it was planning to spin off its U.S. life insurance unit, which is the largest in the country. That represents about 20% of Met's earnings as of the last quarter. The CEO said the spinoff was part of the company's strategic initiatives to increase shareholder value. He said an independent company would be able to compete more effectively and generate stronger returns for shareholders. Met is designated as a "Systemically Important Financial Institution" or SIFI and is restricted in what is can do and required to maintain higher capital levels. By splitting into multiple companies, they can remove themselves from the SIFI designation. Met has more than $600 billion in assets. Shares rallied 8% in afterhours.
CSX Corp (CSX) reported earnings after the bell that declined -5% on a -6% drop in shipments. The company reported earnings of 48 cents compared to estimates for 46 cents. Revenue of $2.78 billion missed estimates for $2.92 billion. The earnings came from a -13% cut in expenses. The CEO said "negative global and industrial market trends projected for 2016 are expected to decrease earnings and revenue." This suggests the health of the U.S. economy is weakening when shippers of all goods complain about slowing traffic. Shares declined slightly after the close.
Copper fell to a new post crisis low at $1.95 as global commodity demand continued to decline. "Dr Copper" is still telling us the global economy is weakening.
Two U.S. Navy boats and crews are being held by Iran after one boat developed engine trouble and both drifted into Iranian waters in the Persian Gulf where one boat ran aground. The boats were moving between Kuwait and Bahrain when the Navy lost contact. The Iranian news agency said the sailors were trespassing in Iranian waters and they were detained. Pentagon spokesman Peter Cook said they had been in contact with Iran and had been "assured" they would be returned promptly. I doubt they will be returned until after President Obama's State of the Union Speech tonight. They will make convenient hostages to make sure the President does not say anything negative about Iran.
Since guns are banned in Germany, there has been a run on Pepper Spray after the gang rapes and sexual assaults over the last two weeks. This graphic shows the increase in the number of people Googling pepper spray. Sales have increased more than 600% and most stores are sold out.
We are due for a rebound. The markets are very oversold but they have so far resisted the potential for a giant short squeeze. On the positive side, the indexes have rallied at the close for two consecutive days and that is the opposite of the prior two weeks.
With the S&P bouncing off 1,900 on Monday, that is an ideal place for a rebound even if only temporary. This is option expiration week and I am sure there are a lot of put options that need to be closed before Friday. Assuming China's market does not implode this week I would not be surprised for the U.S. markets hold their current levels and maybe post some additional gains.
However, the week after January expiration has been known to experience some significant declines in weak markets. When December and January are historically strong the market tends to continue higher. Given the performance over the last few weeks, I would be cautious ahead of next week.
Volume has been very high for the last five days averaging nearly 9.0 billion shares per day.
The S&P set an intraday high of 1,947 at the open and then failed to return to that level with a close at 1,938. That is somewhat troubling but the S&P did manage to post a +15 point gain.
Every prolonged market decline is interspersed with days of temporary rebounds. Until we see a pattern of higher lows, we should remain cautious.
The trading over the last several days has given us some key levels to watch. Those are 1,950 and 1,900 on the S&P. A move past those levels in either direction should see the market accelerate.
At Monday's low of 16,232 the Dow had declined -1,518 points from its 17,750 high on December 29th. That is a significant decline without any material rebound. The minimal +117 rebound today was decent but not on the scale you would expect to see if there was a real short squeeze in progress. It is not unusual to see 200-300 point rebounds if the shorts are really worried.
The Dow rallied +192 at the open before falling back into negative territory at -70 midday. That is not a sign of a healthy market or that shorts are worried about covering. The afternoon rally at exactly 2:PM smells of a buy program and I am sure it was helped by the rebound in crude prices. It does not give me confidence that we are headed immediately higher.
We are oversold. This is option expiration week. We cannot define direction until this week is over because of those influences.
The downside target for the Dow is 16,000 and I wish we would just drop there and get it over with. Secondly, as long as I am wishing I would wish for that to be the bottom and the start of an 11-month rally. That wish has about as much chance of coming true as my Powerball ticket does in being the winner.
Resistance is 16,600 and 16,665. Support is 16,232 and 16,000.
Normally a +48 point day on the Nasdaq would be a good day. While I am not complaining the Nasdaq did drop -543 points from the December 29th high at 5,116 to Monday's low at 4,573. Rebounding 48 points is only a minor gain compared to those losses.
The 2015 leaders are still absent from the winners list with the exception of GOOGL. This means profits are still being taken and there is a fair amount of rotation in progress. That is normally good for the market but it remains to be seen if that rotation will lift it back to the December levels.
Apple helped today after the upgrade and Intel could help on Friday if the earnings are decent. Next week we will begin to get some tech and biotech earnings and hopefully a positive trend will develop.
Resistance is 4,715 and 4,900 with support at 4,600 and 4,550.
The Russell 2000 is the black sheep of the family. The index dipped into bear market territory on Monday and intraday today and only gained +3 today to close down -19.38% from its highs. The 1,036 level is a 20% decline and the low today was 1,028. The small caps are normally the strongest in December and January and this cycle they have been the weakest by far.
Until we see the Russell begin to rebound consistently, the broader markets are going to be weak. However, the Russell is handicapped by a lot of energy stocks and its rebound could be slow until crude prices firm.
Futures are up slightly but China's markets have not yet opened. Crude oil is up slightly at $30.75 at 7:15 ET because the weekly API inventory report said inventories unexpectedly declined -3.9 million barrels for the week ended on Friday while gasoline inventories rose +7 million barrels and distillates gained +3.7 million. I suspect this is catch up accounting from the last week of December when refiners were trying to push as much oil through the system and convert it to refined products before the taxman came to count oil levels. The EIA report on Wednesday morning is the most accurate report.
I am not convinced that today's rebound is the start of a rally. I believe it is just some equalization of the oversold pressures and traders covering their options in an expiration week. Rebounding oil should help somewhat but I do not expect it to continue.
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