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Crude oil bounces

By David Morrison  |  14/11/2018 15:35

Crude oil recovered today following reports of production cuts from OPEC+. The news helped to lift equities, although FAANG stocks suggest more pain ahead

Yesterday’s commentary focused on the sell-off in crude oil. By last night’s close, WTI had registered a decline of 27% from the near four-year high hit in early October. The fall has been notable not just due to its degree and rapidity, but also because prices have sliced through the upwardly sloping trendline that has been building for the last two-and-a-half years, and another that began in June 2017. Yesterday’s note identified the next significant support area for WTI as coming in around $55.40, which marks the 61.8% Fibonacci Retracement of the June 2016-October 2018 rally. This area also acted as resistance between December 2016-February 2017. Well, this is pretty much where WTI bounced. But it needed a trigger, and this came this morning when Reuters reported that OPEC/non-OPEC producers were considering output cuts of up to 1.4 million barrels per day. The question now is whether the bounce has legs. As previously noted, crude was heavily oversold, and it remains so. However, the OPEC+ producers may have to come up with something more concrete than an intention to cut output, particularly when just six weeks ago Russia and Saudi Arabia agreed to increase production as oil approached $80 per barrel.

More troubles in Euroland

Meanwhile, this morning saw the latest GDP update from Germany. This showed that for the third quarter of 2018 the German economy contracted for first time since the first quarter of 2015. The 0.2% quarter-on-quarter decline was blamed on a slump in German car manufacturing. However, there’s plenty of evidence that the biggest Euro zone economy by GDP is struggling. Yesterday we heard that the German ZEW Economic Sentiment survey contracted by over 24 points for the second successive month. This is a ‘forward-looking’ indicator which suggests that German economists and business leaders are particularly pessimistic about the future. On top of this German Retail Sales and Industrial Production have also deteriorated over the past few months. Evidence suggests that China’s economic slowdown is hurting German exporters. Bear in mind that Chinese annual GDP growth has been slowing since 2010 – well before Trump won the US Presidency, let alone fired the first shots in the trade dispute.

US equities

The ongoing bounce in crude oil is also helping to lift US equities. While lower oil prices can be positive as they reduce business overheads, they can also be viewed as a leading indicator of the economy. This is particularly the case if crude sell off on forecasts of slowing demand growth, as is the case now. Big declines in crude lead directly to weaker manufacturing as the oil industry is a huge consumer of heavy industrial materials for infrastructure and associated services. In this respect, lower oil prices are deflationary, although it’s probably far too early to consider that this may colour the Fed’s thinking when it comes to future rate hikes. Nevertheless, Federal Reserve Chairman Jerome Powell is speaking overnight, so it will be interesting to hear if he mentions oil. But despite the early bounce in US stock indices, the majors remain under pressure. The S&P 500, NASDAQ 100 and Russell 2000 are all trading below their respective 200-day moving averages. It’s also worth noting that the leading tech stocks – Facebook, Amazon, Alphabet (Google), Apple and Netflix are also trading below their respective 50, 100 and even 200-day moving averages. This is important as these FAAAN (or FAANG) stocks have been the main driving force behind the US equity market’s advance since at least 2016. Not only that, these are the most heavily-owned stocks so the fact that they’ve come under such sustained selling pressure is a strong sign that the overall stock market’s upside momentum has now turned lower. Now that's not to say that these stocks can’t recover from here, but a disappointing third quarter in terms of revenues and forward guidance has knocked investor confidence to a large degree.

Away from tech

Meanwhile, there are also concerns from old Wall Street corporations as well. Just this week we heard that Caterpillar, one of the main bellwethers of industrial activity, reported its weakest retail sales growth since September 2017. Machine retail sales were down in North America, Asia Pacific, Latin America, Europe and the Middle East. On top of this, General Electric, one of the US’s most iconic corporations saw its stock trade below $8 to hit its lowest level since the nadir of the financial crisis in March 2009. Investors have become increasingly concerned about the company’s high debt levels, particularly given the release of disappointing earnings last month. This is a development which we could start to see play out across other corporations as they struggle to roll over debt in the face of the highest US fed funds rate since March 2008.
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