The Dow spiked to +80 at the open before plunging -319 points to -239 followed by a +213 point rebound and then another -107 point drop to end with a -130 point loss. That is enough to make any investor dizzy.
Oil led the decline with help from Greece, Bill Gross and Jeffery Gundlach. Crude oil declined another -4% to trade under $48 intraday and that crushed the energy sector, which makes up about 10% of the S&P. Saudi Arabia reiterated that slow growth in the global economy was causing the current glut in oil and affirmed that Saudi was not going to cut production.
Crude is in the crazy zone now and there is no doubt we will see higher prices months from now. The amount of global production that will die at these prices is roughly 11 million barrels per day over the next 12 months if prices stayed this low.
The U.S. lost -29 active drilling rigs last week to decline to 1,811 in total. That is down from the September peak for this cycle at 1,931 or a -120 rig drop with most of that drop in the last three weeks (-109). Companies are slashing capital expenditures like crazy and analysts believe we will see at least another 200 rigs shutdown and possibly as many as 400 in the coming months. Since shale well production declines about 70% in the first year it requires a steady stream of new wells to offset the production declines in the existing wells.
Baker Hughes said there were 9,566 wells drilled in the U.S. in Q3. That was a +413 increase from the rate in Q3-2013. That is roughly 5 wells per quarter per rig. We already lost -120 rigs so that means a drop of -600 wells per quarter. If we lose another 200 rigs as the minimum analysts expect that means a loss of another -1,000 wells per quarter or -1,600 in total. Secondarily, the remaining rigs are probably not going to be drilling flat out at the fastest rate possible. Completed wells will slow as companies try to reduce overtime and well costs. They may be contractually obligated by the lease agreements to drill wells on certain acreages but they don't have to drill at a breakneck pace. They can take their time knowing oil prices will rise again 3-6 months from now. The entire sector will go into conservation mode in an effort to reduce costs.
Another analyst that follows large offshore projects said the number likely to be approved for development in 2015 is around 20 compared to a ten-year average of 75 per year. That means 5-7 years from now there will be significantly less production.
The bottom line is that oil is not going much lower and when it finally rebounds it could do so violently because there are so many shorts. This is a twice a decade buying opportunity and funds will be racing into positions once the oil decline stops.
Bill Gross helped push the market over the cliff this morning with a warning that "the good times are over" and "some asset classes will have minus signs in front of them when 2015 is over." He warned that "knowing when the 'crowd' has had enough is often a frustrating task, and it behooves an individual with a reputation at stake to stand clear." He is suggesting that money managers are going to park money in treasuries and bonds rather than risk another bullish year in equities.
He warned that multiple years of interest rates near zero had failed to stimulate growth and that was a warning sign for the future since rates can't stay this low forever. "2015 may see a continuing round of musical chairs as riskier asset categories become less and less desirable." That was a veiled reference to equities. While Bill's track record on calling market tops and bottoms is not exactly stellar he is still an influential person and some managers will move money based on his statements.
Doubleline's Jeff Gundlach warned that "if oil goes to $40 the yield on the ten-year treasury will go to 1%. The geopolitical consequences could be -- to put it bluntly -- terrifying." He is right. Historically whenever there has been a severe decline in oil prices there has been a rise in geopolitical concerns including country defaults, wars and social unrest. Russia, Venezuela, Iran, Nigeria, Brazil, Mexico and even Saudi Arabia are at risk if prices remain this low.
Having Gundlach and Gross talking negatively about the market on the same day created almost a free fall decline that started at 10:30. Add in the flurry of headlines about Greece leaving the Euro and the impact on countries like Italy, Spain, Germany, etc and the outlook for Europe fell once again. The yield on the German Bund fell -16% in a single day.
The yield on the ten-year treasury fell to 1.889% intraday and nearly matched the October panic low at 1.86%. There are some serious deflationary fears in the market.
While on the topic, Mike Lewitt at Bridgewater Associates, projected that low oil prices will have a negative effect on the economy. In recent years oil exploration and production have been adding about 0.5% to GDP. Oil prices at $75 would subtract -0.7% over 2015. That projects that $50 oil could subtract -1.5% from GDP. Yes, low gasoline prices will help consumers but the sudden drop in drilling will produce a wave of layoffs, lack of investment and a drop in services and consumables in the energy sector. Cheap gas is not a free benefit. There are costs.
Over the last two months the estimates for energy earnings have declined from a -9% drop to -21% drop. This has led to cuts in earnings estimates for the S&P from $135-$138 two months ago to barely over $120 today. A drop in earnings forces a rise in PE unless stock prices decline as well. The stronger dollar is also forcing estimates cuts for S&P companies.
U.S. economic reports also pressured the markets. So far in 2015 we have seen eight economic reports and all eight data points have declined. That is not a good start for an economy reportedly coming off two back to back 4% GDP quarters.
The ISM Nonmanufacturing Index for December declined from 59.3 to 56.2 compared to consensus estimates for a drop to 58.2. This is not a good sign since the services sector is normally very busy during the holiday season. This was the third decline in four months.
The new orders component declined from 61.4 to 58.9. Backorders fell into contraction territory with a decline from 55.5 to 49.5. Business activity fell from 64.4 to 57.2. Five industries reported a decline in activity in December. Those were transportation, mining, education, arts and entertainment. Ten industries reported a growth in new orders with six industries reporting declines. Export orders declined from 57.0 to 53.5 as a result of the stronger dollar.
Factory Orders for November declined -0.7% and the fourth consecutive month of declines. Moody's was expecting a +0.2% gain. All types of orders declined. Nondurables fell -0.5%, durables -0.9% and nondefense capital goods ex-aircraft -0.5%. Core capital goods fell -0.5%. Those are a proxy for business investment. It appears that companies are cutting back on capital expenditures and that is slowing new orders.
The Intuit Small Business Employment Index rose at a slower pace in December. The headline number for employment growth declined from 0.15% to 0.14%. Compensation growth declined from +0.27% to +0.15%. Hours worked declined from +0.14% to -0.8%. Workers averaged 25.2 hours per week in December and down -0.8% from November. In theory workers should have worked more in December to handle the holiday demand. However, companies with fewer than 20 employees added about 30,000 jobs in December and the same pace as November.
We will get our first look at the overall December employment with the ADP Employment report on Wednesday. This will give analysts their last chance to revise estimates for the Nonfarm Payrolls on Friday. The current ADP estimate is for a gain of +227,000 private jobs compared to a gain of +208,000 in November.
The Nonfarm Payrolls on Friday are expected to show a gain of +250,000 jobs compared to +321,000 in November. I would be very surprised if we were close to 250,000 jobs and I would not be surprised to see the November number revised lower. However, I have been surprised many times before.
In stock news Michael Kors (KORS) fell -8% after Credit Suisse cut their rating from buy to neutral. The analyst said slowing handbag demand had led to "dramatic" discounting. Christian Buss lowered his price target from $103 to $79 and the stock closed at $67 after a -$6 drop. The analyst said a combination of rising inventories and slowing traffic has led to a dramatic increase in promotional activity in Kors stores and at wholesale distribution partners. The percentage of items on sale in premium department stores spiked +31% in December from +5% in October. On the Kors website the company marked down handbags by -65% in December. Inventory for the quarter rose +53% compared to the year-ago quarter. Sales are only expected to rise +25%. In Q3 the company missed sale store sales estimates of +19% with a +16% number. North America saw sales rise +11% instead of the +15% estimate.
Boeing (BA) delivered a record number of planes in 2014 and beat its own goal for the 787 Dreamliner. Deliveries of the 787 rose +75% to 114. Overall Boeing delivered 723 planes in 2014m up +12% from 2013 and at the high end of Boeing's forecast. Boeing booked a record 1,432 net orders valued at $232.7 billion. The 737 was the most popular with 1,104 orders and 485 deliveries. Unfilled commercial orders reached an all time high of 5,789 at the end of December.
Airbus is expected to announce their 2014 orders next week. They are expected to show 506 deliveries and 1,027 orders.
Transocean Offshore (RIG) got some bad news on Monday. Moody's said Transocean's $9.1 billion in debt could be cut to junk status because of the sharp decline in demand for offshore rigs. For instance the active rigs in the Gulf declined from 60 a month ago to only 54 today. That is a huge drop since these rigs lease for close to $500,000 a day. Transocean has nearly $2 billion in new rigs on order. These were ordered in 2013 when there was a deepwater rig shortage. Now they are faced with a sharp decline in demand and a glut of deepwater rigs at $50 oil.
Verizon (VZ) and AOL are in talks for a potential joint venture or an acquisition of AOL by Verizon according to people with inside knowledge. Verizon has not yet made a formal offer and no agreement is imminent according to the rumor. Verizon said it was more interested in partnerships than acquisitions. Verizon wants AOL's ad serving technology according to the Huffington Post. Verizon is planning an online video product offering and AOL has expertise in online content, mobile video and online advertising. Verizon is chasing AT&T and they need a big online presence to do that. AOL has 2.3 million paying subscribers.
Charter Communications (CHTR) will partner with Cisco Systems (CSCO) to offer a cloud based streaming TV service. This will allow Charter to better compete with companies like Comcast and make changes quickly to their content offerings. Cisco is supplying the data-center and networking equipment the Charter. Because the content will be delivered over the Internet there are no set-top boxes to install and that will allow a cheaper service. This will save Charter roughly $4 billion a year by eliminating the millions of set-top boxes. The service is already in live test with 25,000 customers in Fort Worth Texas. Charter shares fell -$4 and Cisco shares were flat.
After the bell Micron (MU) reported adjusted earnings of 97 cents that beat estimates by a nickel but a revenue gain of +13% to $4.57 billion was slightly below estimates. For the current quarter Micron expects revenue in the $4.2 billion range and analysts were expecting $4.614 billion. Micron said production of DRAM chips would decline in Q2 as it reconfigures production lines with improved technology. This changeover will occur in a seasonally slow demand period. The company said demand for DRAM chips continues to be strong. The minor revenue miss and the lower guidance knocked MU shares for a -$1.58 loss in afterhours.
Monday's market decline was the worst in three months and for a while Tuesday was not looking much better. The S&P is off to the worst ever three day start to a new year.
The S&P declined well under 2,000 intraday to touch 1,992 but rebounded to close back over 2,000 by +2 points. However, that was still under the 100-day average at 2,003.66. Closing under this level is negative but a quick morning rebound could easily correct that. Should the S&P decline back under 2,000 the next key level is 1,987 and the 150 day average as well as strong support from last year. If the 1,987 level breaks it would suggest a further decline to 1,900 or even the October lows at 1,820. While I don't expect that severe of a decline we have to project what the charts tell us rather than what we think is going to happen. If you know what to expect and it happens then you are better off because you planned for it. If it does not happen then we dodged a bullet.
The energy sector makes up about 9% of the S&P and the financial sector is about 15%. Their combined decline was more than the S&P could handle.
The Dow also declined to the 100-day before rebounding but I think that was just a coincidence. The Dow is not very reactive to moving averages because of its narrow 30 stock breadth. Any one or two stocks can easily move it 50 points or more so averages don't work with this index.
The next support level is 17,130 followed by 17,000. The crash in the blue chips can be chalked up to window-undressing by fund managers. They stored money in the highly liquid blue chips going into the end of the year so they would not miss out on any additional gains, their positions would look good on the year end statements but also so they could exit quickly in January and return to cash. They would rather buy a decent dip than just be long at a market top going into 2015.
I think it is telling that oil was down -4% and Exxon and Chevron were only down fractionally on Tuesday. Investors realize this is a twice a decade buying opportunity and the big oil stocks pay nice dividends while we wait for oil prices to recover.
The Dow Transports ($TRAN) fell -145 points even though oil prices were trading under $48. I warned about this last week. Cheap oil is not enough once they reached a certain level. Now there are serious concerns about the economy and the potential lack of freight to ship around the country. If drilling falls off a cliff as expected there will be hundreds of train loads of frac sand, well pipe and oil that will not be shipped by rail. There will be thousands of truckloads of products used in wells and to supply the man camps and communities around the oil fields that will not be moving. The busy airline season is also over until spring.
The transports are a market sentiment indicator for the economy. Cheap oil helped push the index back to its highs but it will take a growing economy to keep it there and analysts have some doubts about the current economic health.
The transports declined to the 100-day average and barely rebounded from that level. The index came within about 75 points from the December low at 8,580, which was also the 100-day average. The February, April and August declines also stopped at the 100-day so we have a good precedent set for a rebound tomorrow. However, the October decline rebounded from that average for two days before rolling over and crashing through the 200-day as well.
I would like to tell you the transports will rebound on Wednesday because of the 100-day but nothing is foolproof.
The Nasdaq crashed through the 100-day at 4,584 but rebounded to close slightly above it at 4,592. The Nasdaq has respected that level in the past but not as well as the transports. Since the big cap stocks can move the index significantly on any single day the Nasdaq is not that responsive to averages. All the major averages were busted in the October decline.
Apple was down -6.5% for the year intraday but recovered to close with a gain of a penny.
The Nasdaq missed making a two-month low by 20 points. Biotechs were the big winners but all the "big" stocks were in the loser's column. Amazon, Amgen, Google, Priceline, Netflix, etc. It is really hard for the index to gain any ground with those heavyweights dragging it lower.
Support is now 4,545 and the December low and resistance of 4,650.
The Russell 2000 was the big loser for the day with a -3% decline of -37 points. Apparently everyone who bought small caps for the January rally were reconsidering their strategy and dumping those stocks. There is almost nothing I can say that is bullish about the Russell.
However, we do have a strange convergence of all the major long term averages at about 1,152. That also happens to be support from the Nov/Dec consolidation pattern. The Russell came within 1 point of that level today before rebounding slightly. In theory the convergence of all these support points at 1,152 suggests this would be a good place for traders to buy and owners to defend.
Wednesday is going to be a critical for the market. We can chalk up the first three days of the year to window-undressing by funds, profit taking by investors deferring taxes on 2014 gains for another year, and further declines in the energy and financial sectors. If the market drop continues on Wednesday then there is something else at work here and we should be very careful about long positions.
Geopolitical concerns are starting to rise and that creates significant indecision on the part of individual investors. They typically don't understand the impact of Greece, the Russian ruble, deflation in Europe, a slowdown in China, a currency devaluation in Venezuela, etc. Most individual investors just want to buy stocks and have them go up. When that does not happen it confuses them and they tend to flee the market.
Wednesday will be critical for investor sentiment. The big afternoon rebound today looked like a capitulation event with a whopping 8.3 billion shares of volume but the -107 point drop right at the close showed there were still some sellers in the market.
Based on looking at a lot of charts tonight I am going out on a limb here and suggest Wednesday will be positive unless there is something else from overseas that produces negative headlines. With oil just under $48 and grossly oversold there is always the potential for a short squeeze that lifts energy stocks and the market.
I believe the market is short term oversold and is due for a bounce. That belief and $3 will buy me a cup of coffee at Starbucks so I would not bet the farm on my outlook. Trade what the market gives us, not what we expect the market to do.
If you have not taken advantage of the EOY special there are only 5 days left before it expires. Do NOT procrastinate any longer.
ONLY 5 DAYS LEFT FOR THE EOY SPECIAL!
Don't forget to reward yourself with our 2014 End-of-Year Annual Subscription Sale! You’ll save $1,147 when you renew now.
The options market isn’t waiting for you. And you shouldn’t wait to keep Option Investor coming at the lowest prices you’ll see for at least a year! There isn’t a minute to spare. Order now.
Renew for as little as $495,
ONLY $1.35 per day
Enter passively, exit aggressively!
Send Jim an email