After a big dead cat bounce in the price of crude oil (CLH16:NYM) and S&P 500 futures (ESH16:CME) both markets reversed sharply lower yesterday. Weak demand out of China, a rumor that Iran was ‘under cutting’ oil prices, and a word that no one thinks possible; recession. The overwhelming weakness that hit the energy markets kept a lid on the S&P all day long with every rally failing.
In addition to the overall weakness of the markets there has been another wave of warnings by some of the big banks. On Monday, Deutsche Bank’s David Bianco said in his new letter that the S&P ‘was clearly in a profit recession’ in the second half of 2015, and suggested the index will probably stay weak until the second half of 2016 when healthy growth returns. On Tuesday RBC Capital Markets global equity team wrote in a research note to clients that most stocks do not appear to have factored in a recession, and should we see a recession, it could be rather severe. RBC analysts said they applied stress tests to their coverage universe, using worst-case price-to-earnings valuations seen during the 2008-to-2009 recession, and the finds point to shares of most companies falling another 50% from their current levels. These warnings have come from several of the big banks this year, and Mondays Deutsche Bank story is off the heels of another Deutsche Bank fixed income analyst saying that given dollar strength, the selloff in stocks and the widening of credit spreads so far this year, their financial conditions index “is now firmly at levels consistent with recession,” and is likely to continue to deteriorate as global liquidity declines.
Last week Goldman gave investors a road map to follow if the economy falls into a recession. David Kostin wrote that, “For investors concerned about a recession in 2016, our recommended strategies of strong balance sheets and domestic sales exposure should deliver relative outperformance even in the event of an economic downturn.” Kostine went on to say, “We believe these strategies should continue to generate strong returns given the trends of relative U.S. economic strength, a rising U.S. dollar, high corporate leverage and oil-exacerbated credit market weakness.”
After a wide range of earnings reports last week, Credit Suisse economists are still expecting growth of just above 2% for the next two years, although they acknowledge risk stemming from credit markets, energy and China. “Given these risks and escalating investor fears, we have taken a deep dive into the implications for U.S. equities if the U.S. falls into recession,” they wrote in a note. The bad news; history suggests recessionary periods lead to a 33% pullback in equities on average. The good news; that is typically followed by a rebound of 62% on average.
As the S&P fell yesterday the front month bond (ZBH16:CBT) rallied to a new all time high at 162.31, another sign that the Federal Reserve will have a hard time taking rates higher in the March meeting and beyond.
Yesterday’s hard decline in the stock market was another good example of how quickly the markets can go from good to bad. As we have continued to point out, it seems like it’s just too early in the year to be looking for a low. The current price action of the S&P continues to be one of failed rallies, and with so many of the big banks warning we have a hard time thinking they all could be wrong. When you throw in JP Morgan’s Marko Kolanovic warning that the ‘Fed may turn the market from water to ice’ one gets the feeling the ice is already forming.
In Asia, 10 out of 11 markets closed lower (Nikkei -3.15%), and in Europe 9 out of 12 markets are trading lower (DAX 1.00%). Today’s economic calendar includes MBA Mortgage Applications, ADP Employment Report, Gallup U.S. Job Creation Index, Treasury Refunding Announcement, 3-Yr Note Announcement, 10-Yr Note Announcement, 30-Yr Bond Announcement, PMI Services Index, ISM Non-Mfg Index, EIA Petroleum Status Report, and earnings from Allstate Corp (ALL), Buffalo Wild Wings Inc (BWLD), CBOE Holdings Inc (CBOE), General Motors Co (GM), MetLife Inc (MET), Merck & Co., Inc. (MRK), and Yum Brands Inc (YUM).
Our View: The only ‘for sures’ in these markets is the volatility. I continue to think it is still too early in the year to think a low is in, or that this increased volatility is just going to disappear or dissipate anytime soon. Today there is a high level of economic reports and earnings out and we expect another big day of trade. Our view is to sell the early rallies and buy weakness keeping an eye on the globlex range.
‘Oil Down 13% In 3 Days, Is Iran Dumping Oil?’
As always, please use protective buy and sell stops when trading futures and options.
- In Asia 10 out of 11 markets closed lower : Shanghai Comp -0.38%, Hang Seng -2.43%, Nikkei -3.15%
- In Europe 9 of 12 markets are trading lower: CAC -0.15%, DAX -1.00%, FTSE -0.51% at 6:30am CT
- Fair Value: S&P -6.48, NASDAQ -8.23, Dow -84.60
- Total Volume: 2.1mil ESH and 17k SPH
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