The euro will need to roll over for the ES to attract sellers.
The euro currency has been on an impressive run (much to our dismay) but few have acknowledged the impact the currency markets are having on stocks and commodities. In the last 180 trading sessions, the euro and the e-mini S&P have settled in the same direction roughly 70% of the time. Thus, strength in the euro has helped hold the stock market afloat.
Similarly, commodities such as crude oil and copper have benefited from the change in currency valuation but might not fare so well if the euro finally succumbs to gravity. In short, if the dollar can find a way to reverse course (AKA the euro weaken) we should see bellwether commodities turn south and they could easily bring the S&P 500 with them. Keep an eye on the currency market, it could be ready to turn the corner!
OPEC failed the markets, but a Kuwaiti Oil worker strike came through
It was only a matter of time before the overly bearish supply fundamentals in crude oil were overshadowed by a supply disruption at the hands of Mid-East turmoil. What some believed on Sunday night was the beginning of another precipitous crude oil decline, quickly turned into a sharp energy rally on news of a Kuwaiti oil worker strike. Adding fuel to the fire was a report released this morning by the U.S. Energy Information Administration suggesting distillate stocks (heating oil/diesel/gasoline) experienced small declines. Remember, commodity markets don't need an actual change in fundamentals to turn things around, they just need the perception that it is possible. In other words, crunching supply and demand data isn't going to change momentum.
The direction of crude oil matters to financial futures traders because it is was a big weight on equities earlier in the year. Higher energy prices eases concerns of contagious debt defaults in junk bonds, and could eventually put layed off shale oil workers back on the job.
Event risk is looming in the financial markets.
On a scale of 1 to 10 this week's calendar event risk is a 12. We will be hearing about home data, employment data, manufacturing data, and sentiment data all while attempting to digest a mid-week Fed meeting (did I mention the State of the Union Address?). Economic data has been consistently strong; it doesn't make sense to expect otherwise. Yet, the financial markets have reacted to both good and bad data in the same manner (buy stocks, sell bonds, sell the dollar, etc.). If there is anything that could change that pattern, it would be a good old-fashioned price squeeze. Big events such as Fed meetings and payroll reports are often the catalyst for such last hurrah trend extensions followed by eventual reversals. This week feels like it is setting up to be one of those times.
Despite a lack of economic data in the US, the markets found a reason to bring the ES to 2100ish.
The economic data schedule was skimpy in the US this week so investors were focused on news coming out of China. Word of Chinese exports tumbling 10% while imports also softened by 1.9% triggered global selling in stock indices. However, as has been the case since early 2016 market corrections are merely a signal for dip buyers to put money to work. Overnight and early morning losses were quickly shored up by afternoon trading.
On the lows of the day, technical oscillators were suggesting the sell-off had gotten ahead of itself. As it turns out, they were right. However, the lack of volatility has become silly. A 50 point decline in the S&P shouldn't constitute an oversold market.
Tomorrow's docket is relatively busy. We'll digest inflation data along with the latest consumer sentiment readings.
The E-mini S&P traded lower two days in a row for the first time since late September.
Although losses were minimal, the ES managed to settle in the red on two consecutive trading sessions to close out last week. In a normal market this wouldn't be worth a mention, but in this market, it is a rare occurrence. The last consecutive negative closes took place on September 25th and 26th. Before that, you have to scroll the chart back to early August!
I doubt the _bulls_ are concerned in light of the fact that the ES is within 15 points of its all-time-highs. On the flip side, the _bears_ must be growing concerned over the fact that the seasonal tendencies from Thanksgiving through the end of the year generally call for higher stock prices.
That said E-mini S&P futures traders are holding one of the longest positions we've seen this year. Thus, one has to wonder if the bulls will soon run out of capital. After all, most of the bears have already been squeezed out of positions. This is true even in the stock market, the percentage of outstanding short positions on individual equity products is near record lows.
Trade tariff talk is just that, we've yet to get anything concrete. Yet, the market is emotional.
This is nothing new, if there is anything we've learned from the first year (+) of the Trump presidency it is the conversation always starts with drama, but then settles down to something more reasonable. Unfortunately, the markets haven't quite figured that out yet. Those that believe markets are efficient, will have a hard time explaining what we've seen in the previous three or four trading sessions.
Tariff discussions, without any concrete decisions, can't explain such big swings in asset prices. The only rational explanation for this type of volatility is (ironically) irrationality. Markets are emotional, and we are being reminded of that. The low volatility slumber of 2016 and 2017 were anomalies and are probably behind us.
The "buy and holders" might not be happy with the market environment before us, but the reality is the expanded volatility will eventually provide opportunities for traders (particularly option sellers). Further, it might not feel like it but this is a healthier market than what we saw in late 2017 and January 2018.
The ES bears have a slight edge, but they need to move fast.
The S&P has gone into correction mode but the selling has been tepid. The complacent bulls haven't been given a reason to second-guess their bets; if the bears want to make progress they will want to see something happen sooner rather than later. The longer prices hover in this area the more likely the edge will shift back to the bulls.
The meaningful economic reports and the bulk of corporate earnings are behind us. From here, the market will have to find a way to stand on its own two feet. In our opinion, the legs of the bull are a little shakey. Assuming we don't receive any surprise tweets or trade tariff resolutions, the ES should creep into the 2780ish area and Treasuries should begin to make their way higher.
Inflation in check and economic data steady
Yesterday we learned that October retail sales ticked to .8% beating expectations of .6%. We saw similarly positive news from the Empire Manufacturing index which was a positive 1.5 for the month of November despite a negative reading of 6.8 in the previous month. This morning, the government released the latest Producer Price Index (PPI) suggesting that inflation was stagnant. We'll get a clearer picture tomorrow morning with the CPI (Consumer Price Index) report, but if it is similarly benign we expect Treasuries to move higher on the news.
From yesterday's newsletter just in case you missed it:
Although it isn't grabbing headlines like the Treasury market is, the US dollar index likely holds the key to our financial future. If you recall, a stronger dollar puts pressure on commodity prices such as gold, crude oil and even the grains. We are also seeing money from overseas investors rotate into the greenback in search of yield and equity market performance. However, if the dollar continues higher, there could be trouble ahead for domestic asset prices.
For instance, if the dollar index breaks above 101.50 it would likely result in a breakdown in commodities (below support levels which have been in place for months, and in some cases years). Similarly, Treasuries could continue to plunge. After all, if foreign investors are paying "top dollar" to exchange their currency to purchase securities, current Treasury yields won't be worth their while. They'll be looking to the equity market for gains.
There is a lot of event risk floating around.
If it isn't Chinese tariffs, it is a Trump administration investigation or Russian/Syrian turmoil. We've gone from a world seemingly without risks throughout most of 2017 and early 2018, to a world in which there are peripheral threats in every direction. That said, despite what it feels like volatility isn't as high as it could be. Although we are seeing large point swings in the stock indices, the percentage of the swings is relatively reasonable given the height of the market and associated risks. Further, the VIX is relatively tame when compared to past volatility.
Where the ES goes in the short-run is obviously akin to a crap shoot. Nevertheless, looking back at historical patterns it is generally a poor idea to bet against the S&P 500 as it is trading in a trough ahead of earnings season; earnings seasons have a tendency to reverse trends.
Energy stocks have likely been holding the market up.
Crude oil, and now natural gas, have made impressive moves higher. As a result, energy companies making up a significant amount of market capitalization and playing a big role in the US economy has been positive. Nevertheless, if crude oil prices come back to reality ($50s?), that will work against stocks.
In our view, the oil market is an accident waiting to happen. A few weeks ago we wrote a piece suggesting the intermediate-term top in oil would likely be somewhere in the mid-to-low-$70s and we still feel that way. Speculators are overly long, seasonals are starting to turn bearish, and the market has probably over-priced supply concern risk premium. Lower oil will likely translate into a lower S&P 500.
We aren't ultra-bears in the stock market but we do think the easy money on the upside has been made. The market looks and feels tired, the weekend trade news celebration was short-lived, and we are seeing trading volume disappear as we head into the summer doldrums.