Saturday, October 31, 2015

Oil Markets in Review: October

Just about a month ago, analysts were clamoring about the historical prospects of October where indexes typically saw the worst performance of the year. And as if it actually meant anything, reports began to tout the negative outcomes that the first month of the third quarter could produce, especially after the dismal performance of the quarter before. It seems elementary to believe the independence of monthly statistics, but some investors can't help but attribute a kind of seasonality to the apparent pattern. Once again, though, there could have been some sort of contrarian sentiment underneath the bearish rumbles. Some people may forget about that equal and opposite reaction prominent in physics, but like anything with momentum, the adage can apply in financial analysis as well. The concentrated efforts of the bears in the third quarter have diminished and given way to short-term and long-term bulls that traded in the way of the bull market birthed at the end of the financial crisis of 2008. It seems as though we've seen the worst of the year with the lagging biotech sector flattening out, commodities posting more gains, and the energy sector leading broad-based increases when they come. Looking at the numbers, the monthly gains actually prove to be some of the highest in years. Th U.S. large-cap index, the S&P 500 gained about 8.3% this month as the index surges over its 2,000 level despite a -7.58% loss accumulated in the third quarter. The Dow Jones Industrial Average saw similar gains, in October, with the index growing 8.47%. But the bounce off of third quarter disappointment wasn't apparent just in the United States, European markets jumped this month as well with help from the ECB's love affair with quantitative easing. Investors traded the France CAC 40 up 9.93%, the Germany DAX up 12.32%, and the Netherlands AEX up 9.73%. The Euro Stoxx 50 shows the systematic bullish fervor that encapsulated the European states with a growth of 10.24% countering losses of -11.3% in the third quarter. China's initial weakness has appeared to waver as well with an October surge of 10.8% following losses of -24.7% in the third quarter. The difference shown by the numbers are astonishing with a month of gains canceling out almost three months of bearish movement in some cases. As bearish sentiment and volatility sought to chase investors out of the market, the bullish streaked October brought more back. Third quarter months averaged 13.01 billion shares traded a month, a statistic that was topped by the girth of October trading at 15.27 billion. The heavier volume statistic can probably be explained by the popularity of trading around earnings season which was in full swing by the close of the first Q4 month. Although earnings and sales have been generally lower, smaller expectations have caused there to be more surprises, and thus, more bulls. All sectors have felt this surge with their constituents in the S&P 500 all in the green for the past month. Utilities, the worst performing in October, grew 1.05%, but materials and energy each led the market at 13.45% and 11.25% respectively. These two sectors lead the rest even though their price to earnings ratios rose throughout the third quarter. Because of this, some analysts are wondering whether the current market prices are overpriced despite relief from the economic slowdown that plagued third quarter performance. Although, others would argue that recovering commodity prices will help repair revenue deficiencies from companies that rely on price to retain earnings. That seems unlikely, though, as inflationary pressures quickly turn to nil and threaten the strength of the labor market that will probably experience little to no wage growth. In September, personal income in the United States grew a meager 0.1%, falling to its expected value of 0.2%, The September value was 0.3% less than the past five months which each experienced growth of 0.4% in their respective months. Optimists, though, point to the rebound crude oil prices made in October. In 2015, the supply glut causing low energy prices has been the blame for a decrease of cash flow in the economic environment.  Consumer prices have, in turn, dropped an average of -0.01% a month for the past twelve months. These statistics are the main reasons for the Fed's dovish monetary policy even though employment statistics has pretty much reached full capacity.

So where does the energy sector go from here? A sector with YTD return of -12.9% certainly has some upside to it, but only what crude oil contracts have allowed. Many might attribute the October rebound to bears cashing in on shorts or bulls taking advantage of oversold equities. For that reason, the gains of the past month could be considered due to technical strength helped along by earnings trading. Exxon and Chevron, which both grew at about 1% on Friday, have total losses of -10.50% and -18.17% respectively for the year. These companies, with the best credit ratings of the industry, have shown that even they are vulnerable to price changes. Whether or not their (and their peers') October gains are due to technical strength is undecided. We do know that fundamental changes cannot be the case as P/E levels have only risen. Perhaps the gains are attributed to bets for the recovery of the crude oil price. Brent and WTI prices both had a bullish month, gaining 2.33% and 3.42% respectively, with most of the trades being fueled by production and stock data released weekly. The performance in October was supported with tapering volume statistics as open interest tapered off from September highs. Short positions established also reached a new high by the end of October with long positions remaining flat. Price forecasts for the end of the year are $51.35 according to Factset. These figures may seem plausible as production is set to drop off due to the possibility of defaults and a reduction in investment spending from all oil and gas firms. We'll end this October review with a ratio comparison of WTI and the S&P Energy index as well their technical drivers.

Coming into the summer months, the energy sector and WTI contracts correlated pretty weel with neither outperforming the other. In July though, there is a clear shift to the energy sector outperforming the gains or losses of the WTI benchmark. This could be attributed to energy stocks being oversold while WTI was experiencing an increase in oil production. This lead to a high in outperformance from the energy sector, but it was soon to be corrected. The chart makes a V-shape, showing the disparity between what energy stocks traded at and the capital limitations they saw due to low oil prices. The two converging blue V-patterns exhibit a small bubble, perhaps, where energy stocks (especially oil and gas firms) were overvalued compared to oil price and subsequently corrected. The October correction appears to be a smaller form of the correction which bottoms quicker than it gains. I suspect the fourth quarter may follow some of the same cyclical movement as WTI finds its appropriate spot price for the end of 2015. The energy sector, so far experiencing a great fourth quarter, may be more linked to oil price through the end of the year as its performance converges into correlating with the oil benchmark.

Wednesday, October 28, 2015

FOMC Leads A Market Surge

The results are in. Deliberations have been deliberated, and the Fed Board of Governors can once again retreat behind the economic curtain where the markets will continue to masticate upon their own heavily digested thoughts. Markets showed modest gains on the day as investors patiently waited for a statement to be produced at 2:00 p.m. today. In that memorandum, Chairwoman Janet Yellen surprised listeners with the abdication of the arbitrary prose of meetings before. With the omittance of questioning how long to preserve low rates, the statement hinted at small feelings of urgency as it mentioned that more serious decision-making will occur at the December meeting. On top of rate hikes being delayed until December (possibly), the FOMC decided to leave out key phrases citing worries over the global slowdown and the high probability that the 2% inflation target will not be reached. In fact, the Fed's statement opined that "moderate" growth has been sustained for some time after the September meeting, making a rate hike of 25 basis points plausible in the next meeting. How did the market react? Looking at the two days before the Fed announcement, major indexes lagged with the energy sector bogging down the rest. Losses, though, were contained to under -0.50% with very positive earnings reports from tech companies like Apple and Google. Today, we saw a small dose of volatility with a small whipsaw accompanying the FOMC release around 2:00. In the morning, Dow Industrials and the S&P showed parsed gains with the expectation of rate delays. Upon release of the statement, equities took a hit and erased gains but nor before bouncing back to new highs. DJIA and S&P 500 finished at 1.13% and 1.18% on the day. Global markets' trading mostly ignored the Fed statement as a lot of the policy put forth in the message concerned  the domestic markets such as inflation and the labor market. The Global Dow lost -0.40% with small intraday highs and lows. Who enjoyed today's message the most? There are three groups that can be mentioned explicitly:

1. Mid-cap and small-cap stocks enjoyed seeing rate hikes put off for at least one more month. Because of a slowdown in consumer spending and export numbers, companies who needed that the most were experiencing lower than usual cash flows. The fact that the FOMC Board is looking to support businesses on the operating fringe helped spur investor confidence in firms with weaker market capitalization. Showing this increase in bullish sentiment surrounding smaller companies are gains in the S&P Mid-Cap 400 and Small-Cap 600 indexes totaling to 2.03% and 2.75% respectively. The Russell 2000 grew 2.92% adding to a list of small- and mid-cap indices that performed better than their large-cap counterparts on the day.

2. The energy sector and WTI crude oil contracts both saw bullish surges today beginning with the expectation that low interest rates would be preserved and ending with the confirmation of another month of cheaper borrowing. Wednesday morning opened with a sharp incline in crude oil prices as supplies were shown to grow slower than expected despite three previous weeks of supply gains. Juxtaposed with a rate hike delay energy companies jumped as cheap debt will be important for companies crunched by low prices and negative cash flow. The S&P Energy index grew 2.22%, and the NYSE Arca Oil index grew 2.02%, both outperforming the Dow Jones and S&P major market indexes.

3. Lastly, the bond market received helpful information today to help alleviate some volatility that has recently plagued the market in charge of pricing debt. Unlike recent trading of the Treasury, long-term U.S. government debt saw an increase in yield as prices dropped after the FOMC statement caused many investors leave bonds for equities trading. Two-year bills saw the largest yield increase as the probability of gradual rate hikes in the next year increased dramatically. As equities continue to get more attractive as the economy warms up, expect bond yields to increase to levels modestly higher than those before rate hikes as earnings rise by the end of the year.

One thing that will worry commodity traders and companies associated with them is the strengthening of the dollar against Euro. After easing from Europe and Asia, consumers saw a systematic drop in the Euro's status in order to help struggling exports. As this happens, American producers see their exports to European customers get pricier. Right around the time statements were coming out of the Fed, the Euro dropped over 1% to a new low between the two currencies. On top of hurting U.S. exports, foreign money flowing into U.S. investments, both equities and commodities, could be hurt in the near future, endangering badly needed expanding GDP numbers.

So where do we go from here? Currently, the market is trading on an atmosphere that will enjoy easy monetary policy for another month as the Fed looks to bolster stable inflation growth by supporting payrolls. Moving into the holiday season, consumer spending is expected to rise along with energy prices expecting more demand from heating. These bullish figures along with consistent moderate growth should give Fed enough of a reason to raise rates, which should be a good signal to the markets. Instead, near the end of the year, there might be another slight correction as a gradual plan of tightening is introduced. Right around the December meeting, or perhaps in response to the comments by Yellen, economic reality should kick in with the resumption of healthy interest rates and a normal growth number. Tomorrow, investors should be looking at the newest GDP statistic that will become an immediate guide for the FOMC in December. Meanwhile, keep an eye on crude oil prices to see if deflationary pressures show any sign of lifting.

Janet Yellen, The Yoga Instructor

Days before the FOMC's meetings, the spotlight shifts to focus on monetary policy. Traders on the floor and the internet find ways to tune into the world's largest central bank's mind. Where once the Maestro led with few words, now come parched attempts of explaining the Fed's economic plan. In charge of the U.S. monetary positions, Janet Yellen must extricate the country from the particularly sticky situation offered by the world's recent slowdown. A correction in August ruled out interest rate hikes for the rest of the year. All the while, the Fed's Chairwoman must find routes to unwinding her central bank's expansive asset positions instituted on the balance sheet during the 2008 Financial Crisis, a traumatic period during which she served as a Fed Board member. Tons of issues clutter the meeting's atmosphere, towered by the global economic slowdown which continues to echo in statistics coming out almost every day. During this trading session, both the indicators on U.S. durable good production and consumer confidence came in lower than expected. The index measuring consumer confidence actually saw a difference of over 5 points between the real (97.6) and consensus (102.8) statistic. That certainly doesn't support rate hikes this meeting and adds to the power behind the low probabilities traded on the Fed Funds future contract. After many governors have done all but guarantee near-zero rates, the meeting becomes refocused on sending the right message to markets, both domestic and foreign, which both reacted to the actions of the Chinese and European central banks. But communicating those positions is not always easy. To make use of a metaphor, imagine a yoga instructor walking her students through an exercise. In order to emphasize fluidity and core strength, she highlights the importance of slow, deliberate movements to shift from pose to pose. Janet Yellen must be the markets' yoga instructor, but her comments and concerns must be thought-out, gradual, and deliberate. Choppiness in both yoga and macroeconomics is very unhealthy and increases the risk of volatility. With the use of very soft, but hopefully very direct, language, the markets must be massaged back into a position where growth is normal, and rate hikes are sensible, much like an athlete stretching to reach optimum athletic performance. Fed meetings are also important because they can make a huge impact on the stock market for just happening, and sometimes that effect can be exacerbated by what people think will happen.

The market has a useful way of letting the market bet on the future of the Fed Funds rate, a monetary tool that used to be hidden behind a veil of uncertainty. Now, traders can buy and sell contracts based on how they think the Fed will rule each month, providing a method for the Federal Reserve to check how they well they communicated their desired position. The chart above plots the projected interest rate in the next year. According to the futures contracts, investors do not see rate hikes as anywhere near likely until the middle of 2016. In fact, through March 2016, the Fed Funds future contract predicts interest rates to stay below the upper bound of the currently bounded policy instituted by Bernanke's Fed during the recession. Interest rate movement is not expected to see increased consideration until April of 2016. My chart reflects an initial increase of 25 basis points at the first round of tightening, and thus, see interest rate projections below 37.5 basis points as still being assigned a small probability. With this in mind, investors predict that rate hike probability won't be over 50% until August of 2016, a year after the correction that changed the Fed's course of action. What does this tell us? As of now, this is the "monetary narrative" that investors see the Fed following. Janet Yellen will look at these numbers and decide whether they describe the Fed's actual plan because if they do not, she will have to use careful language to adjust them appropriately. Providing plenty of warning without an outright explanation of what is to come encompasses the crux of a central banker's job in market communication. With the use of tools like inflation targetting and various charts and data produced by the FOMC, comments and announcements can affect long-term interest rates assigned to Treasury bills as well as risk spreads on corporate debt. With errant or convoluted remarks comes the chance that further volatility can plague the bond market making firms and their investors unsure of how to value debt. This will become very important as energy companies struggle with cash flow problems, and corporate earnings drop overall. As we wait in the lull between Fed announcements and the beginning of the week, expect another day of limited movement with the direction of major indexes being determined by recent earnings and the performance of oil. But for investors looking to the future of stocks, many predict a dimmer outcome as tightening becomes increasingly likely. Futures contracts for the Dow and the S&P 500 show a major drop-off of about 1-2% of each index, reflecting the belief that a bearish move might be due with a higher Fed Funds rate. Touching on the yoga metaphor once more, the stretching and limbering of systems that have been slow will bring on much soreness after intense action is reintroduced. For the U.S. economy, a bull rally will not just fall on our feet, instead, healthy GDP growth and respectable inflation will only show themselves with value to escort them.

Please excuse my delving into monetary policy. I realize that my focus is on oil and energy for this blog, but my forays into other topics can't help but spill over into my writing. So please, enjoy my deviations and enjoy an eclectic approach with me.

Also, 10,000 views. Thank you all so much!

Monday, October 26, 2015

Energy Lags on a Neutral Day

We're at it again. A bullish run from the end of last week appears to have been capped once more with muted movement. Poor performances from tech stocks as well as natural gas firms lead the decliners while advancing stocks made out almost as strong. After a weekend full of central banking activity, the U.S. markets begin to shift their focus to an FOMC meeting scheduled to convene soon even though rate hikes appear very rare. Trading today followed the ECB's hint at more quantitative easing, and, more recently, the People's Bank of China's decision to cut interest rates, reduce reserve requirements, and extirpate a cap on deposits. As worldwide stimulus hits the global economies, markets have responded. Trading sessions in Europe and Asia showed particularly evident jump during the end of last week on Oct 22 and 23. During those days, the Shanghai composite grew about 250 points (7.29%), and the STOXX Europe 600 grew about 20 points (5.33%). The local economic efforts reached farther than domestic markets as a the easing had a trickle down effect on globalized economies. In the same time, the Asian Dow grew 30 points (1.02%) improving on a monthly return of 12.14%, and the Global Dow grew 48 points (1.95%). Behind these numbers, the Dow Jones Industrial Average continues to support a bullish rally with a 10.19% gain on the month. The S&P 500 with a loss of -0.19% still supports the overall bullish tinge that accentuates the market with gains up to 10.07%. With a rather nondescript opening to the week, investors look forward to Fed deliberations as well as a thick earnings week that threatens more immediate adjustments with a poor third quarter. Apple, one of the most talked about companies in the United States (if not the world), saw a 3% decrease in their price as projections for their earnings report come in as dim. As large-cap companies continue to  implicate the global slowdown, the current bullish rally looks more and more like a facade of investor speculation. Everyone remembers a time when the Dow was this high, and it was thrown off a cliff. Almost three months ago, the correction wasted billions of dollars as the major indexes shed their girth. Now, money seems thinner, with more central banks applying easy monetary policy than the first half of the year, and rally keeps going. Something seems out of balance (though we are constantly reminded that the pendulum always swings back to equilibrium).

Just as a pendulum has conflicting forces acting upon it in movement, so does the overall stock market which is pushed and pulled by sector performance on any given day. Today, seven out of ten sectors fell behind, but not substantially. Gaining sectors played a large enough role where bulls and bears were mostly canceled out. The slightly negative orientation of the market can be attributed to losses in the energy sector (again, how ironic that this blog is about oil). WTI contracts fell to a two-month low at $43.98, a loss of -1.40%. This was caused by bearish supply data which saw increasing oil imports and no slow down in production. The PHLX Oil Service index fell -2.53% showing where the declines were most concentrated. Now being factored into the outlook for oil companies is the problem of default as cash flow continues to be a problem for small and large oil firms alike. Although, the credit issues will lie with small-cap and some mid-cap energy stocks that are no doubt already experiencing the risk premium being assigned to them. On the national level, countries that are major oil exporters will see higher risk premiums as well if supply and demand problems stay low on an international level. While the loss in the oil industry loomed largely, this next of energy kin on the futures exchange experienced even greater losses, natural gas. In a trading session that saw a multi-year low, natural gas contracts fell a total of -9.8% at one point, a loss of $0.22. While it may seem inconsequential, natural gas price plays a huge part in integrated energy services that have relied on their diversification to survive the price slump. All of the biggest oil majors have plays in natural gas, and the fossil fuel is increasingly becoming a major source of powering homes and more. Further deflationary pressure from this commodity could hurt industry associated with manufacturing and housing.

The technicals of the natural gas contract were a clear signal of a bearish reversal. The blue numbers up to five show natural gas price repeatedly dip below the 50-day moving average until finally breaking past it on the fifth bounce. I suspect a resistance could be established around there. At the same time, a bearish price channel seems to have developed as well and had implicated some sort of downtrend in the long run.The ceiling of the pattern was validated three times after bulls pushed up to that level then receded. A bearish reversal looks even more apparent as today's session began with a large gap after four previous losing sessions. While the gap could be one of exhaustion, volume stats argue against that position. The Chaikin Money Flow indicator shows huge amounts of money flowing out of the energy commodity. This came after bullish peaks that got lower and lower as rallies lost their moment over time. The MACD shows three bearish crossovers and two bullish crossovers in the past two months, a sign of significant movement to come. The large spread on the last move hints at a move with more substance. The only bearish indicator, the RSI measure of momentum, had shown a steady overselling of natural gas into this month, Short-term strength that is often shown by RSI may be overshadowed, though, as the energy situation continues to worsen with bearish commodity prices. I expect this to be a significant move with lower prices entering a trading period under the resistance created by the 50-day trend line.

Thursday, October 22, 2015

Recovering Emerging Markets

Just like the Fed, the European Central Bank has the venerable reputation of serving as the monetary and financial giant that keeps global economic engines running. Accompanied by an earnings season that has companies constantly meeting or beating their low expected EPS projections, ECB press releases appeared all the more exciting with Mario Draghi in the spotlight. Investors in this report are looking for signals of the continuation of quantitative easing despite some misgivings about its effectiveness. If it does look like QE will be pushed into the end of the year, European securities should see an increase in price. Sure enough, Draghi's comments gave investors the feeling that more stimulus is needed. Even though comments like that could be taken as a contrarian indicator, traders supported gains caused by the preservation of loose monetary conditions. As the Fed and the ECB continue to coordinate their dovish policies, stock markets have responded positively. The Dow Jones Industrial Average and the S&P 500 show the resumption of the bull rally with gains of about 1.70% and 1.63% respectively. Correction losses from August have almost been reversed as the indices reach continue the push to their yearly highs. European stocks skyrocket with 2% gains shown in Germany, France, Spain, and Italy's indices, and pared gains from the UK leave them at gains of 0.44%. Two economic indicators came out today supporting the upturn that investors traded on today. Unemployment claims fell more than expected in the United States as home sales grew more than the consensus. The labor and housing market are two essential parts of the U.S. economy that represent the health of consumer spending. Bullish sentiment on both ends makes stock market equities and bonds spring forward. Whether this reignition could turn into another bullish surge depends on how long lasting a monetary effect can be with most of the sluggish figures behind us. The U.S. continues to push for a growth rate just above 2.5% and China just below 6.9%. The market seems to want to support that argument that a bullish market is in effect, and investors are using earnings surprises to boost their support for sectors. Tech firms like Alphabet and Amazon revealed earnings surprises that boosted their gains of 2.16% on the day. Even though most of the gains originated in European and U.S. markets, emerging market economies also enjoyed the stimulus reintroduction that will make European goods cheaper and boost asset prices.

In the bond market, sovereign debt bonds in Italy and Germany increased in price dramatically. As yields go down, European nations will be able to fund their debt cheaper and support the stimulus spending that is needed to fight the slowdown. As the Euro weakens on worldwide currency exchanges, the strengthening foreign monies will help supply confidence to net exports in emerging markets. The chart above compares two securities that measure a basket of world economies: in green, the MSCI Emerging Markets Index is compared to, in black, the MSCI World Index Fund. These derivatives track mid-cap and large-cap stocks across different economies depending on the stages of development which characterize them. Although they are not often recognized, emerging market economies are perhaps the most important areas of growth in the world. Their high GDP expansion drives many parts of already industrialized economies.Sectors like industrials, basic materials, and commodity-based firms rely on demand from these voracious economies in order to maintain revenue levels and expand infrastructure. Demand in countries like China, Brazil, and the "Asian tigers" have become vital to superpowers like the United States, Germany, and Britain because of their exceptionally high GDP figures (China's was as high as 10% at one time). Global turmoil this year began in late August with the introduction of Chinese weakness and a week of corrections in the U.S. markets. Billions of dollars left equities and bonds, and emerging markets felt the retreat the most. Further weakness was most likely caused by low oil prices draining profits from oil exporting nations like the Arab states. The rebound in September is shown as a slight nudge forward with retracements just under 50%. Looking at the Emerging Markets Index, we see a significant underperformance as the global fund outpaced them during the month of the rebound. The Chaikin Money Flow indicator also shows marginal amounts of money flowing into the bullish trend that came after the correction. Conditions might have also been hurt by a poor third quarter as well as a stronger dollar making most commodities more expensive to the blossoming new industries looking to take advantage of industrialized help. At the end of Q3, we see another correction in both of these indices which retouched the previous low from the correction, Subsequently, another rebound came about in the bullish month of October. Emerging markets seem to have surged more consistently in the fourth quarter as its growth has almost mirrored that of the world index. Once again, the CMF shows that volume levels support the apparent trend with far more capital moving into emerging markets once again. It is not completely sure that the rebound is solid, but improvements of industrial goods and oil futures on the commodity market has shown a healthier improvement indeed. For investors looking into those sectors (consumer goods and energy) emerging markets are an important indicator of expansion and a bullish market.

Tuesday, October 20, 2015

The Great Gridlock

It's the beginning of another week full of financial and economic goodies that will make prices toss and turn once more. Market forces constantly being forced into gridlock provide no insight on whether the global economy is gaining speed or continuing its slowdown. Yesterday, major market indices either jumped (or dropped) just a tick above (or below) zero. A historical trader would reference the doom and gloom typical of October's keeping investors on the fence where a bullish rally invites them on one side, and the other a fearful bearish retreat. With supply and demand forces constantly parrying each other, traders trade like they're playing waiting moves as they anticipate guidance from larger economic powers. Most of these people buying and selling stock can't diagnose the global economic condition, so they are left on the backburner as economists try and interpret the complicated atmosphere in which we find ourselves. Even in their analysis, constant contradictions occur, and a haziness has set over the monetary horizon. Central banks seem just as confused when they were so determined in the near past. The Fed has repeated the need to raise interest rates above their current levels of nonexistence, but futures betting on the hike don't project rate hikes until next year. The European Central Bank is currently meeting over whether to continue their quantitative easing program, an $80 billion financial panacea that was supposed to boost asset prices and weaken the euro. That was apparently not the case. Mario Draghi now faces the decision of whether to continue the expensive program while praying it boosts the lagging eurozone nations when debt-filled nations threaten more crises in the future. Even China's supposedly obvious economic sickness has become a convoluted mess of bouncing economic figures and doubting analysts. Turbulation apparent in these situations should evoke volatile trading, but that hasn't been the case.

Ever since the tripling of the VIX index at the end of August, trading has settled down into a consistent decline that has assuaged the fears revealed by the correction. Over the past two months, a falling price channel has developed as the volatility index falls almost -64%. Meanwhile, the index levels fell well below the 50-day simple moving average and recently below the 200-day moving average. Those crossover points represent short-term volatility lowering below long-term and mid-term levels. Investors should be more bullish and continue in that fashion, but we still see intraday fluctuations and pared gains (and losses). If volatility is dropping, group psychology should suggest that buying pressure should overcome the market, but it has been stemmed by an equal amount of selling. Where is the fear coming from if it isn't coming from volatility? The answer may come from the research of Daniel Kahneman, one of the leading behavioral economists doing research today. His theories summarized by prospect theory cite the importance of doubt when individuals take on risk. Conventional economic theory says that individuals will not discriminate between bets with varying risk that have the same expected value. For example, a person is given the choice between two bets: a 50% chance of winning $100 and a 10% chance of winning $500 (both have an expected value of $50). Orthodox utility theory suggests both bets should be chosen equally, but Kahneman has shown otherwise. Instead, he showed that the introduction of more doubt makes that option less likely to be chosen. Consider this example. a person is given the choice between two bets once again: a 100% chance of winning $99 and a 99% chance of winning $100 (same expected value of $99). Kahneman's premise of the overbearing power of our lazy intuition suggested that participants would choose the sure option more than the less sure option (even though it is only 1% less sure). This comes from a risk-averse mindset that infects our minds. We hate losing, so we seek the option that reduces the possibility of a loss at all costs. Kahneman also showed that participants were willing to take a premium for more certainty. For example, participants might choose a 100% chance of winning $80 instead of a 90% chance of winning $100 (first option, expected value is $80, second option, expected value is $90). 

These ideas about risk taking and betting can be taken to the current condition of the stock market. Imagine the average investor choosing between the options of trading with a higher expected value but more risk and the certainty of money in an uninvested state. Because most individuals are loss averse, the typical buy might go away. In a market which is clearly improving volatility-wise but becoming increasingly uncertain about which way to move, investors are surely being scared away from committing to a position. Instead, trading short-term margins has been more evident with the small fluctuations in the day-to-day trading. In the current bull rally, we've seen the most effect from contrarian indicators that saw energy and consumer good sectors rebound, but other than that stocks have had slurred performance. Typically, when equities confidence becomes fuzzy, traders flock to bonds, but even there Fed policy has convoluted the future of interest rates, teasing bondholders. Once again, today's trading reflects the hourly whipsaws with little convincing movement as advancing and declining stocks balance each other out. The Dow Jones initially dropped but has stabilized to a -0.02% loss. The S&P 500 flew down then up and finally centralizes at midday with losses of -0.19%. Even the Global Dow shows similar fluctuations with an intraday high and low both 6 points higher than the current middle to which it has trailed off. The sector that has been most affected by global convolution is the energy sector which continues to shuffle the overall demand and supply levels for energy with the continuation of murky data. Analysts from different firms and the EIA in the U.S. constantly produce contradicting data and reports that predict production and consumption figures in the near future but may have very little merit at all.

Chinese GDP supposedly grew 6.9% in the third quarter which is just 0.1% less than what the target was. Although it seems like a pretty clear figure, observers are not trusting this number, and it has limited its effects on the global outlook. The chart above demonstrates the aimless WTI benchmark that cannot find a direction in which to move. After two clear moves, one bearish and the other bullish, the past two months of trading has elicited a continuation pattern for the past two months. Today, WTI contracts lose -1.00%, but still no definitive trading activity has overtaken the market. Investors continue to bounce between the 50-day and 200-day moving averages, hinting at some rebound that could be in the positive direction. Going forward into the end of the year, investors should look for clear information into what way the market will turn. Time after time, I stress that misinformation and unclear situations will almost always be dissolved by bigger organizations like the Fed. Earnings season is providing individual stocks with fundamental adjustments, but the trend is not broadly-based. For traders looking to establish a long or short position, my suggestion is to start looking at sector performances as they may be more directional at the moment. After that, find a stock with fundamentals that are likely to be proven strong as technicals are proving to be very muddled at the moment.

Saturday, October 17, 2015

Bullish Technicals and Bearish Fundamentals

In the history of the stock market, the month of October is notoriously known for its bearish overtones. Investors since 1927 seem to want to sell during the first month of the fourth quarter with no apparent pattern to be recognized. Although the bull market since the end of the financial crisis in 2009 has produced Octobers with less capital outflow than those that came before. In fact this year, the first half of the month has boasted capital inflows of almost $1.2 trillion as a result of the recent bullish rally. As a reaction to Fed monetary policy, traders have garnered confidence behind securities that will benefit from the continuation of 0-0.25% interest rates. The averages serving as a litmus test for the trading floor have soared in the first three trading weeks of the new quarter. 

Gains in the NASDAQ, the NYSE index, the Russell 2000, the DJIA. and the S&P 500 have surged about 5% with few days of losses. As a result, most of the ground lost from the August correction has been recovered with some questioning the existence of a bubble forming once again. While the gains could be representative of long traders closing out bearish bets, it seems highly unlikely given the volume levels behind the growth. After initially dropping during Oct 14 losses, bullish volume increased through the end of the week for both the Dow Jones Average and the S&P large cap index. Equities haven't been hurt yet by lower corporate earnings that are expected to show up as earnings season progresses. 

Nevertheless, technicals may still suggest a more solidified reversal into bullish territory. After a small bullish flag developed in September, we've seen a "break out" coming through the resistance in October. On top of that, volume seems poised to support the growth after a small bearish lapse. A similar pattern can be seen on the S&P 500 chart but with more variability, This may lead some observers to blame technical traders for a false signal especially when fundamental adjustments will be the primary force behind price movements over the next three weeks. This may be especially true for energy companies which are expected to be extremely disappointed by revenue levels as a result of low oil prices. Friday, investors reacted to Schlumberger's moribund revelations with an initial selling session that stabilized to a higher low.

Interestingly enough, the technicals of the oil services company showed bullish signals coming out of Thursday's session, After five straight days of gaining, they peaked above the 50-day average with the possibility of a continuation pattern developing. On Friday, prices dropped below the 50-day trendline to settle at $74.51 (and were briefly trading around $72.50 levels). The bearish day was an obvious result of bearish fundamental data that interrupted the rally. The blue line shows a trendline which could develop after Friday's losses. The potential for a continuation pattern might still be there, but, strong selling pressure developed by the end of the week implicating a reversal. With a Friday that had reacted like the DJIA average, SLB technicals could have been pointing to a bullish price channel seeking to extend gains from the beginning of October. Money flow in volume and the CMF indicator supported the continuation pattern with Oct 14th and 15th showing rising demand in the short-term. The question is, how will poor energy fundamentals affect stock prices that are bullish at the moment? If we take SLB's decliine on Friday of (-2.16%) and apply similar losses to large cap oil stocks, will technicals hold up the bullish trend?

Above, XOI has been charted for the month of October showing the bullish rise and the movement into an apparent continuation pattern. Like SLB, the index seems to have slowed into a price channel which may result in more gains as volume returns to the demand side. The red dotted lines show a -2.00% loss in the hypothitical seting of a poor earnings report. In my opinion. a 2% decrease in stock price might be average for all  oil and gas firms as a fundamental adjustment, although, small cap stocks may come out worse. In the initial review of the index model, technicals don't seem to react to poorly to fundamental adjustments of 2%. Trading could be stuck in a continuation pattern for the duration of earnings season, but the improvement of supply data might become an impetus for breakouts. It is not usually the case that fundamentals and technocals disagree,but the divergence of the two can represent misinformation in teh pricing mechanism. When comparing past patterns and current situations, the strength and priority of the information behind the move is important to deciding an overall trend. On the trading floor, investors must recognize that the division in trading type can create relevant deviations in price expectations. For example, price can jump during bearish fundamental situations as technical traders cash in positions with notable limit levels, and fundamental traders can sell a security when bad news is revealed even in a period of technical strength. For oil and gas companies, I see the bullish technical side coming out on top as low revenues are expected and supply issues will improve.

Thursday, October 15, 2015

Equities Bounce Back off Fed Hopes

Another earnings day passes us, but this one is traded in a different direction. As Wednesday's session was littered with worries over retail performance given Wal-Mart's profit outlook, today traders bounce back with some bullish sentiment supported by a rally in the financial sector. Even though there were losses reported in bond trading, both Goldman Sachs and Citigroup surprised investors with an EPS $0.03 above the forecast. If anything, it gives hope to individuals with major doubts about the system. Many traders are also reacting to the recent reports of "modest" economic numbers that should fend off the Fed's desire to raise rates. Many dovish dissenters, like FOMC Governor Tarullo, have already revealed their preference of stalling the rate hikes. As a result, the Dow Jones Industrial Average bounded up 217 points to register a 1.28% gain, reaching a 7-week high. The S&P 500 grew just a little more reporting gains of 1.49%. The United States was not the only country enjoying a day of pleasant trading as equities across Europe and Asia grew today with many major indices increasing more than 1%. The Dow and S&P now have one bounce off the 17,000 and 2,000 levels which could be established as new supports. Another major move concerning Treasuries today could show more faith in a rebound. U.S. Treasury bills with 10-year maturity rates dropped dramatically in price today as yields maintained small growth over the 2% rate. This movement comes as investor sentiment surrounding rate increases gets stronger, and equities markets attempt to push for more stability. As stocks closed much higher, crude oil moved in its own world. WTI and Brent closed slightly down with losses of -0.60% and -0.90%. A report from the EIA sent bears into action as stocks were seen to grow by about 7.6 million barrels over the past week. With that, many of the gains posted in the last week were reversed. As the commodity price weakened, oil ETFs actually finished in the green. OIL, one of the most popular bets on American crude, grew by 0.11%. UCO and UWTI grew a little bit more with their accelerated status. Energy companies fared well today in the bullish market with the Dow Jones energy and the S&P energy index both gaining 1.24% and 1.63% respectively. Energy companies struggling to maintain cash flow are hoping for the Fed to maintain low-interest rates. With more support behind rate hike delays, investors are more willing to bet on the sector to survive. Depending on when traders see WTI rebounds, the momentum behind oil and gas firms will accumulate. Today, gains from the energy sector topped 1.58% with coal as the leading industry within the group.

Another important event today produced an earnings report that could be important for the oil services industry. Schlumberger is one of the first of its industry to reveal third quarter numbers, and they came out just as expected. An expected earnings-per-share of $0.77 was barely topped by an actual $0.78. Due to low oil prices, earnings fell substantially by 49% from the last quarter. Most of those losses were caused by a squeeze on demand and benchmark price in the United States. Foreign business fell less which highlights the weakening situation in the United States. Revenue fell by 39% as well, but initiatives to reduce costs helped to decrease operational spending. As investors see one of the largest oil services entities taking major damage from the fundamental situation, I'd expect a loss in confidence in oil and gas firms as they produce similar results. In the post-market session, Schlumberger shares fell -0.7% with more shorts to come in the morning.

Wednesday, October 14, 2015

A Deflated Earnings Season

Just like the wall of Jericho, great fortresses can fall. Even Warren Buffett's portfolio is vulnerable to losses, especially in what may appear to be a bear market. This week, third quarter report cards of some of the largest financial players are being dealt out, and investors are trading reactively. Statistics are being thrown every which way to elicit a favorable response in stock price, and those listening are adjusting the equilibrium based on the respective change in fundamentals. As we switch mentalities from a macroeconomic perspective to a microeconomic focus, all eyes are on earnings reports that have been lackluster so far. Today, sour reports from Netflix and Wal-Mart weighed on media companies and retailers likely recoiling from the information revealed. Overall, the Dow Jones Industrial Average dropped about 150 points or -0.92%, and the S&P 500 skidded -0.47% by the end of Wednesday. Wal-Mart, a leading loser today, fell a whopping -10.04% to hit almost $60 a share on the day. This came after reports that EPS outlook dropped to $0.99 which is down from $1.08 in Q2. Investors took this as more than a signal of company weakness, but they also sold off many shares of cheap retailers like Target, Dollar Tree, and Dollar General which lost -3.50%, 3.28%, and -4.21% respectively. It seems bets are being piled against the expansion of money as disposable income continues to be squeezed by low levels of inflation and struggling wage increases. For that reason, politicians could see favorable sentiment surrounding minimum wage increases. NASDAQ losses of 0.29% were lead by disappointing earnings from Netflix. Amongst other distasteful figures, the streaming company cited a slow down of U.S. subscribers in Q3 compared to Q2. The total fell well below its 1.15 million projection at 880,000 and share prices suffered for it with post-market losses up to -3.03%. While indices appeared relatively weak today, most of the major losses could be attributed to poor earnings surprises. In reality, total volume on the NYSE was about even with 411 million bullish and 459 million bearish. NASDAQ traders were even more neutral with 935 million bullish and 951 million bearish. Sector performance had offset each other on the day with 4 out of 10 gaining.The two largest gainers today, basic materials and energy, traded in that way as commodity market movement showed more gains. With both the S&P and the Dow below support levels, we might see bounces off the 2,000 and 17,000 values to reverse losses today. WTI and Brent crude benchmarks both lost on the day at -0.69% and -0.18%, but oil and gas services gained. Perhaps positive movement could be attributed to a small weakening of the dollar, or short traders covering their spreads. Either way, the next big move among fossil fuel companies will be earnings revelations.

Oil and Gas Large Cap EPS Consensus
from WSJ
As a preview, I've compiled four of the large cap oil and gas stocks to analyze their consensus outlook. Nothing seems to be improving earnings-wise as every company has had to reduce outlooks from a month ago. No Q3 earnings-per-share projection is above the projected result of Q2 (HAL is about equal). Only CVX is looking to improve upon their disappointing 0.56 result in Q2 as their upstream operations proved to be extremely inefficient. Looking to Q3, projections into the last quarter look to be adjusted for a continuation of low crude oil prices. Energy firms will also be discouraged by a falling PPI (producer price index) which showed deflationary pressure increasing when the -0.5 loss trumped the projected result of -0.2. Overall, I would look for deflated numbers in earnings reports across the boards as consumption slows down along with overall confidence in the economic health of the country. On top of that, commodity-based companies and industrials will be hurt by lagging emerging markets and a constricted China. Both have already shown their effect through a drop in exports and the Fed's indecisiveness surrounding interest rate hikes. 

Tuesday, October 13, 2015

The Emotionally Charged Crude Oil Market

The bulls and the bears both had their go around today's trading session as a parabolic session leaves shares slightly lower than yesterday's close. After a light holiday session on Monday, investors sidestepped their way into the middle of the week with intentions to trade cautiously. Upon open (and after a slight loss from Dow and S&P futures), traders appeared to have been realizing short-term long positions which were established about a week ago. The Dow Jones low today, near 17,030, experienced a rebound to the green until selling pressure pushed it to a -0.12% loss late in the trading session. The Dow's returns are still positive for the trading week and remain bullishly above the 50-day moving average with the spread between the 200-day average inching smaller. Volatility gained for the first time in as VIX grew about 7.15% today. The NASDAQ and the S&P 500 showed patterns similar to the Dow's whipsaw movement but sustained losses around -0.35%. Investors continue to be wary of uncertainty surrounding an overall market move that neither their peers nor the Fed have sought to clarify. Globally, stocks performed marginally poorly as the Global Dow dropped by almost a full 1% on a volatile economic environment. The Dow Jones Transport fell -1.73% hinting at broad-based weakness that could develop into more downside risks for an economy looking to bounce. As the earning's season of fundamental adjustments presses on, price movement is most likely to be muted by an absence of macroeconomic direction. The Fed's hands remained tied until their next FOMC meeting as any emergency rate change would signal an urgency unhealthy to the financial system. Economic data has had nothing but a tepid effect on the psychology of investors who remain stoic in the face of resilient manufacturing data, stalled job growth, and a decrease in imports. Inflation, for the most part, remains relatively undisturbed despite easy monetary policy, and the money supply continues its shuffle between bonds and equity investments. Perhaps we could be observing a waiting move as crude oil prices look to make a major move after a small bullish surge. WTI and Brent benchmarks ended with losses even though they showed almost 2% gains midway through Tuesday. Instead, down about 1% each, Brent crude oil drops below the $50 level once more. The International Energy Agency produced a report today highlighting concerns of a supply glut continuing into 2016. Investors were glad to listen as the energy sector dropped -1.32% with large cap stocks losing as much as -1.95% and -1.71% (Marathon and Shell). As depressed prices continue, firms are gradually pushed to tighten spending with operation cost reductions or job cuts. Some companies caught in this position of decreasing wages as opposed to firing workers which create skilled shortages and share price attacks. Small, marginal decreases may signal investors that the oil and gas industry see a recovery in the near future as long-term solutions are not being used.

An issue that is typically discussed during a glut, but not always addressed with the proper perspective, is the notion of accurate fundamental pricing. Given the efficient market hypothesis, the commodity market should measure futures contracts at a value that takes into account all available information. Many investors feel that profits can be made because the market valuation is not this way. Similar to any supply and demand model, systematic movement in the equilibrium should create proportionate movement in prices. With a dash of emotional investing (illegitimate claims of a bullish or bearish outlook), profit taking might be possible.

Oil Price Compared To Production Statistics

Using a comparison of the U.S. and international benchmark spot prices and domestic supply statistics, an observation can be made about the amount of losses that were associated with supply increases. From the highest point in 2014 (the week of 6/13) to the latest supply report (10/2), WTI losses amounted to -56.31% and Brent losses to -56.19%. These losses began after fracking projects started increasing U.S. production and forced OPEC to compete for market share. Investors started shorting and selling with long positions being established periodically. After those positions were sold, the process repeated until traders had sunk its girth by more than half. Meanwhile, supply increases began midway through 2014 until its peak around the end of 2015's third quarter. Now, an 8.2% increase has been established with more decreases in the near future. Below the charts, I've calculated the rate of WTI/Brent losses per 1% increase in supply. The results were quite dramatic. Over the past year, prices have dropped almost 7% with one percentage supply gains. On average, an increase of 88,245 barrels a day of U.S. production would cause a -6.87% move from the WTI benchmark. After it's put into perspective, it appears there might be at least some emotional trading behind selling. While this doesn't discredit major bears, it still sheds a light on how drastic they have been reacting. Some may argue that the international situation is very different with OPEC increasing production by about 1.3 million barrels. I might argue on the contrary. OPEC themselves have forecasted almost 1.6 million barrels a day more consumption with lower oil prices. Yes, Iraqi oil is scheduled to slowly come back onto the market, but global investments in oil are also scheduled to drop by $500 billion by 2016. Could it be true that the fundamental situation has been overcome by the bears? Volume data behind price decreases have been thinning out with bullish surges matching and sometimes exceeding the crowd being the sell-offs. Prices are still more than half their high, but the supply and demand situation is improving. That is why I continue to be bullish on oil. Not eccentrically bullish, but enough to see prices back around the $60 at the New Year. The efficient market hypothesis is a very valid thought process, but in the fundamental case of the fossil fuel glut here, it may have to be dismissed as free markets finally take over the pricing of petroleum. OPEC's power has shifted away from them, but that doesn't mean illogical sentiment should overwhelm the pricing mechanism that is the free market.

Monday, October 12, 2015

Oil Comparison with Commodity Index (BCOM)

Last week, investors traded on a positive group psychology with many stocks experiencing eccentric support from buyers across the board. Most sectors grew for at least four out of the five days with Friday ending a bullish streak with some consolidation. The Dow Jones Industrial Average repeated that same movement today with a confirmation of gains at 17,120 and a positive change of 0.25% today. The S&P 500 and the NASDAQ indices sought to maintain price levels as well with parsed gains of 0.10% and 0.18% respectively. The Russell 2000 small cap stock index fared a little worse posting losses around -0.17% as an economic recovery continues its fragile course. Even as asset prices appear to be shakier, the volatility index dropped -5.15% upholding a substantial 5-day decline of -22.68% as it approaches its 52-week low of 10.88. The Dow Jones Transport Index performs rather neutrally today with a small 0.03% climb, but it continues to outperform the industrials in the short-term. Overall, the main market indicators show a week deviating from the forces of last week. Supply and demand powers seemed to have reached an equilibrium point where traders are looking for a fundamental change to push weight behind either movement. On the NYSE and NASDAQ, advancing and declining securities balance each other out as the week starts. Momentum appeared to be muted by a lagging energy sector which reacted to a drop in oil prices as well as a production report from OPEC. This comes as lost weeks gains were supported by a surging energy sector and bullish movement in WTI and Brent crude oil prices. The gains might have been short lived as futures contracts have WTI and Brent oil losing -4.43% and -4.35% on their spot prices reducing 5-day trading gains to 4.13% and 3.73%. These losses came after OPEC reported that member production had reached a three-year high as monthly production increased 1.57 million barrels a day over the target of 30 million. This may appear atypical of the cartel which has constantly desired to keep high global oil prices, but with the war for more market share and revenue, member prices are unlikely to ease up on production in the near future. The absence of an OPEC meeting, as well as Saudi oil price cuts, has discouraged investors looking at the cartel for quotas to relieve the ailing crude oil prices. We could see more bearish volume on the futures exchange when traders banking on quota installations abandon their assertions that OPEC will fall back to their track record. At the same time, Iraqi oil on the market looms in the back of Brent traders as supply gluts have the potential to increase. European stocks responded to the deflationary pressure like the U.S. markets. With Brent falling, the Stoxx Europe 600 edged lower at -0.28%. Also characteristic of today, government debt prices increased and yields dropped as investors move towards safer assets as hedges against possible losses.

WTI Comparison With Bloomberg Commodity Index

Lately, a lot of talk around the commodities market has been centered around the crude oil plunge and the supply glut. As one of the most important global products, it may deserve that spotlight, but that doesn't mean that the overall commodities rout should be ignored. As crude's price hovers at about half its previous year's price, precious metals, agriculture, and other various groups of commodities have experienced volatility from the recent economic contraction as well. It may be useful to compare an index with the WTI and Brent crude prices to see how bad petroleum is really performing. In the chart above, WTI and the Bloomberg Commodity Index have been plotted together for comparison. This index was chosen as the futures market "average" because its components cannot be weighted more than 33% at any time. Therefore, this ensures that energy products are not dominant in deciding movement. The purple line shows WTI movement as the black line represents that Bloomberg index (BCOM). Looking big picture (on a one-year time scale). one can clearly see the significant decline in commodity performance. The red and blue arrows follow the general direction of the two charts. The arrows mostly coincide showing a lot of similarities which is too be expected as crude oil price is included in the basket index that it is being compared too. Through the beginning of the oil supply glut, crude oil along with its counterparts on the futures market performed very poorly. Going into 2015, the economy was looking at a drop in inflation that could endanger the struggling labor market. Through April, crude oil and the Bloomberg index moved together with WTI doing considerably worse. The rest of the commodities appeared to be struggling from the immense amount of money leaving the domestic crude market. Companies who were too afraid to lose their low priced hedges prepared for even lower prices. The WTI rebound midway through the year allowed the establishment of long positions and subsequently trading at the top around $64. BCOM entered a slightly bullish consolidation trend. Its gains were hindered by the continuation of  lagging commodities. Throughout the summer, both fell as the global weakness produced worries of la stronger dollar hurting exports for the United States as well as overall demanding being questioned as China slowed down. As the third quarter ended and the fourth began, oil prices quickly jumped ahead of BCOM with the jump in September more pronounced than the basket index. Why is that? Perhaps there is more downside pressure from the economic environment. WTI price might be gooing through a period of fundamental readjustment where the recovery is stemmed by glut implications. The bullish bounce has not been confirmed as robust and may be long positions being established and sold in the short term. Either way, money is moving into the energy commodity as shown by the money flow indicator. It could be that a crude oil move was supported by more volume and speculation than other commodities that attempt to weather out the storm of low inflation. The futures market as a whole should be looking for the Fed to stay on top of a 2% inflation target and fight for labor market strength. Strong communication for Yellen might mitigate anymore losses from crude in and commodities in BCOM.

On a side note, this weekend is fall break for mysemester, and I have been reading an excellent book fresh off the press. Ben Bernanke's The Courage to Act is a great piece on monetary policy during the financial crisis in 2008. Not only is it an investigation of the Federal Reserve's actions during the crisis, but it provides refreshing analysis of the psychology behind the Fed's communications. For investors today, it might shed some light on the failures of Yellen's attempts to clarify her idea's on monetary policy and why the markets are responding to her so viciously.

Thursday, October 8, 2015

The Bull's Strength

Markets opened this morning with a slight loss but progressed steadily to continue the bullish breakout that has taken the market by storm this week. Later in the day, the Fed released their minutes pertaining to their decision to delay raising rates. Investors responded to the citations of global economic risk and the need for loose monetary policy. The inflation target remains far away even though commodity futures continue to increase. The Dow Jones Industrial Average surged to a 0.82% increase after an initial -0.25% loss during morning trading. With those gains, the market index passes the 17,000 level after a correction in Augst dropped the value below 16,000. The moves have been robust, but a lot of analysts seem worried that the extra girth will not be maintained. The S&P 500 grew 0.88% as well as bulls won today. Just like the Dow, the Fed's minutes pushed the large cap index above the 2,000 threshold just 100 points from the year high. The Global Dow, as well as Europe's Stoxx 600, grew marginally on the continuation of a global bull trend. No sectors in the red today with energy leading the way once again. The gains were certainly systemic as 2,376 advancing stocks fueled their respective sectors. The Russell 2000 also grew 0.92% as small-cap stocks rallied with the Fed's minutes out in the open. Perhaps the biggest surprise comes from the commodity market where WTI and Brent crude oil shot up today with gains measured at 3.89% and 3.34% respectively. The U.S. benchmark remains dangerously close to the $50 level where dramatic shifts in the market could affect institutional and investor psychology. Oil and gas companies gained as XOI jumps 2.56%, and the energy sector rode their coattails with a 1.89% boost in the S&P Energy index. ETF's following oil rose dramatically as well as investors were able to take advantage of bets in favor of the bullish run.

How can we accurately assess the strength behind the gains that has got investors perplexed on which way to move? Long-term growth looks especially feasible as Fed rate hikes look to be delayed for the near future. For this reason, higher debt ratios don't appear as lethal as some would comment. On the other hand, short-term economic weakness has investors worried about global demand and how that will effect inflation and, in turn, payrolls. Currently, the pool of money is circulating slow and appears to be shrinking as emerging-markets are buckling down with the possibility of a recession.

Looking again at the Dow Jones Transportation Averager over the Dow Jones Industrial Average in a ratio analysis, one can see a general market strength indicator. Typically during bullish periods, the transportation sector performs better that the industrials. This chart shows a slight, sudden jump by the transportation index which is highlighted by the blue arrows. This follows an underperformance that marked a bearish movement in the overall market. Here, the chart shows a jump in money flowing into the transportation sector which has been lagging so far this year. The green line shows a trendline with two confirmation bounces that has a very slight positive slope. One of the most important things supporting this rebound is the Chaikin Money Flow indicator and the volume levels. The ratio analysis is supported by volume that is growing with the trend. Systematically, one should see boosts in volume across the board if bullish movements are to continue. We have looked at a general market indicator of bullishness versus bearishness, but perhaps an analysis of the volume behind these bull moves can tell us more about the strength behind the positive movements.

from WSJ

In the image above, there are three tickers charted over the past three weeks with measurements of their volume data associated with the directional movement of price. On the top, the S&P 500's average volume for the bearish movement before the bullish was almost 100 million greater. Although this was due to an outlier which causes that average total to surpass that of the bullish movement, it seems necessary to acknowledge that day. In the end, bullish days have higher volume with the exception of the major sell-off day midway through the bearish week, Volume levels rose about 8.1% consistently as the fourth quarter introduced bulls to the markets. Below that chart, two images display similar data for two big oil and gas integrated services which have come to represent that industry (and sometimes the energy sector as a whole) in the Dow Jones Industrial Average. Looking at the bearish movements on either end, one can observe a stunted lost that was supported by one day of large volume on Sept 20th then tapered off into consolidation. Reversal days weren't necessarily high volume days, but they were not ill-supported either. Both CVX and XOM recorded an average bullish volume almost 2.5 million higher than their bearish trend. Trading behind XOM gains increased 15.3%  and 23.0% for CVX over the past week. With comparison to the market average of volume, oil and gas's surges seem more robust than those in other sectors. As crude futures have been exploding upward, investors have elected the energy sector as the best performing in almost every bullish trading session. With substantial boosts in the crowds behind oil and gas stocks like XOM and CVX, I see no reason to doubt that this trend will survive. Traders are still establishing long positions as estimates of price objectives continue to get more optimistic, and those holding shares are not going to sell yet. On top of that, last quarter's performance, as well as dubious analysts, act as a contrarian indicator for uptrends. Viewing the energy sector from the perspective of the overall market, one can assume that higher oil prices (possibilities of the 50's) will free up the frozen bullish sentiment that was hiding amongst the bears. OPEC and the IEA have predicted a slowdown in energy investments with supply data supporting their outlooks. Investors beware: this may be the quarter that the energy sector takes you by surprise. This breakout should be taken seriously.

As I finish my 50th post and as you finish reading it, I would like to thank you for all the support from my audience. It has been so helpful receiving the positive words that are offered to me. This blog is not an obligation; instead, it has become a truly pleasant process. Thank you once again for reading, and I hope that my content will continue to improve as I become more educated in my research.

Tuesday, October 6, 2015

The Death of OPEC: Shale Fracking

The turn of the quarter seems to have breathed some life into the equities and commodities market as Tuesday's session continues to cap off gains from the recent rallying. To begin with, the S&P Volatility index (VIX) has dropped for the fifth session in a row, ranging from a high of 25.88 on September 30 to a low of 18.82 earlier today. Stocks and commodity securities seem to be cooling down after an economic atmosphere riddled with slower growth prospects was illustrated during the summer and emboldened by Fed rate delays. The Dow Jones struggles to maintain its bullish surge from the past couple days as it shifts around the break-even point with losses of -0.16%. Up until now, around $700 billion worth of stock has been restore. These gains, of course, lead by surges in the energy sector. Notably, the Dow Jones Industrial Average finally jumps up to its 50-day moving average once again.The S&P 500 trades pretty neutrally midway through Tuesday with a pared loss of 0.48%. It seems that the wind has left the proverbial sails of the investor's pockets, and it can't help but feel like bulls have been put out to the fray. The Russell 2000 index, a ticker related to the performance of small-cap stocks, is down the most on this rickety Tuesday with losses measuring -0.95%. This can probably be attributed to the increased pressure in a weak economic environment on small-cap stocks. Tightened emerging markets have increased the U.S. trade deficit as well as German factoris. In response, the International Monetary Fund downgraded their global economic outlook to 3.1% at their latest conference. Goldman Sachs moved their outlook for rate hikes to the Federal Reserve's December meeting with higher probabilities assigned to moves in 2016. Advancing stocks edge out declines by about 400 according to NYTimes with a less saturated trading day. Supply and demand forces seem lodged at current price levels with fundamental and technical indications struggling to topple each other. The healthcare sector, the only losing sector on the day, are one again squeezed by the mirage of falling drug prices. On the other hand, energy's rebound continues as volatility in the sector transforms into a real bullish move. The entire sector is up about 3.91% on Tuesday, lifting a 5-day change to 10.80%. Industrywise, oil and gas drilling and integrated services sections rise the most at 6.33% and 3.28% respectively. Chevron and Exxon-Mobil were among the biggest gainers in the Dow today with steady positive movement of 3.52% and 1.48%. Much of the oil and gas industry acted in that way continueing the potential behind bullish reversals. Why did these reversals appeared sustained? WTI crude oil futures rose dramatically today with gains up to 6.01%. The new price level sits just under the $50 mark as new confidence is found in production declines. Brent crude, today, topped that mark as it shot up $2.86 more to land at $52.73. A 5-day performance of WTI has chopped year-to-date losses to -16.58%. 

2014 IEA World Energy Investment Outlook Shale Investment
2014 IEA World Energy Investment Outlook

Amidst the major gains in the oil and gas industry (and perhaps even contributing to them), OPEC released a report describing a global cut of $130 billion worth of petroleum investment spending. Multinational companies are not the only ones cutting capital expenditures as even OPEC governments now running trade deficits are experiencing this run on capital. Even with all this, everyone keeps pumping in a global dash for market share that has isolated many of the consumers looking for an industry with high profit margins. Instead, even the largest firms are racing to grind down costs of operations as the market appears less and less monopolized by OPEC oil wells. Saudi Arabia just recently was forced to cut their oil price because of the U.S. overproduction. In a miraculous year, the crude oil market has seemed to stumble into a semi-competitive system dominated by large firms that can apply economies of scale to succeed. But with the shifts, a brand new batch of success stories takes competitors by storm. The shale frackers, through innovation and technological breakthoughs (like most new success stories), developed a way to get that oil which was originally out of reach. In the figure above, the IEA researched fracking projects and forecasted what costs and cash flow in those projects would look like over time. With such high initial costs and long-term gratifications, bleeding governments can't afford to take on negative cash flow for almost ten years. It hurts economic conditions, weakens currency against the dollar (which prices most crude benchmarks), and makes borrowing costly. So what about American producers, why are they managing so much success with a project that returns almost -$300 million worth of cash flow in the first five years? The key is a capital system that provides many routes to the necessary credit to fuel long-term investments. Firms can use the assurance of future production and liquidity as collatoral as well as their current traditional assets. On top of that, smaller producers that wish to get in the mix have the ability to begin a capital intensive program and receive assistance from a larger firm with more experience and cash flow. Take for example a recent move by Suncor to work with Canadien Sands Ltd. Low crude oil and natural gas prices have caused these projects to become extremely unprofitable (as most are still in the appraisal or facilities and growth phase), but in the next couple of years the cash crops will pay outl, especially as prices stabilize once more. Global demand for these ligrter, sweeter products will increase after price drops increase consumption and economies of scale keep pricing competitive. That is why OPEC is scared, Because a technological breakthrough and a superior product will flood the market (as export bans are lifted), member economies based on the commodity will be strapped for cash. Asian demand is most likely slowing down and has already caused major cuts in the Saudi oil benchmark. OPEC Secretary-General Abdalla Salem el-Badri, according to Wall Street Jounal, has plead for U.S. production to negotiate for a higher price! What does this mean for the future in oil and gas? Production declines should be evident in the first couple of years. This may not be so evident as capital expenditures increase which would rightly prompt the expectations of productions of increasing. Not with initial large-scale shale production. As prices get higher, fracking innovation will only stand to get better. Appraisal and development costs will drop inevitably leading to more efficient production, and the price will react.The real question is how long the world is going to allow itself to remain petroleum dependent. There will be a push to electric cars, and there will be a tapering off of demand in the long-run even though shale fracking will get cheaper and cheaper. For now, oil and gas companies should come out on top due to these capital expenditure programs supporting new fracking projects. On Q4 reports, I would look at capital expenditures, operating costs, and lon-term debt to see where a company might be in its long-term agenda concerning shale interest.

Monday, October 5, 2015

Bullish Reversals in Oil and Gas

Friday's trading session ended with bullish sentiment left to cultivate after the closing bell. The weekend wasn't enough to separate those feelings from the investor's portfolios, and they might not be speculated feelings as Monday's trading session showed the real possibility of a bullish reversal. The Dow Jones jumped 1.85% to post total gains of 304 points, beating Friday and approaching the 50-day simple moving average with hints of a reversal. Volume today was just under that of Friday's with a convincing move nonetheless. Five-day performance jumps to 4.84%. The S&P 500 large-cap index showed gains of 1.83%. The jumps sent the price level surging above the 20-day moving average with a chance at approaching the 50-day resistance level. Five-day performance increases to 5.59%. The reversal indicators seem contagious, and oil and gas stocks are feeling it too.

WTI Crude Oil Reversal October 5, 2015

WTI crude oil finished today with a $0.55 gain after the bullish trading day on Friday. Its increase of about 1.20% bounced off a 7-day trendline and a 30-day trendline to surge forward with decent volume almost as strong as Friday. The gains come after the development of a symmetrical triangle continuation pattern that traced the 30-day simple moving average as the support. After three bounces off that level, traders should be looking for a continuation of the bullish trend that exploded at the end of August. If the flag "flies at half mast" like it usually does, the price target can be set at $56.50 with a bullish MACD crossover and increasing buying power from the money flow diagram. Look for a day of positive news to boost sentiment on the event of new rig or production data. That respective trading session should boast higher volume levels and maybe even a gap if the news is available early.

OIL WTI Crude Oil ETF Reversal October 5, 2015

As a result of the surging gains in crude oil price, ETFs connected to their price have experienced similar technical activities. UCO jumped 3.19%, UWTI rocketed up 5.02%, and OIL gained 1.76% on Monday's great trading day. Above, a chart describes the movement of the most common ETF related to U.S. crude oil status. The money flow diagram shows an increase in volume behind the derivative with an MACD crossover supporting the surge. Rising volume through the past five trading days also gives the increase significance. Price seemed to be stuck in a channel with a month of trading, continuation activity, but the recent growth could give grounds for a breakout past the resistance. In fact, today the security opened with an upward gap which could signal a breakout. The past two trading sessions show the price bouncing off the 30- and 7-day moving averages with the 30-day moving average serving as the support which was repelled. OIL may be heading for a continuation of the bullish trend in August. Maybe a replication of the gains in that month?

XOI Oil and Gas Companies Reversal October 5, 2015

Up next, the performance of the oil and gas companies is analyzed with this chart. It is not zoomed in as much because the movement is much easier to see. Over the summer, there is an overall bearish movement to a low point in late August where the market shifts to a consolidation phase with a wide trading channel. The support around 1020 is tested twice with the second bounce leading to the four-period breakout move. The MACD line shows a very convincing crossover with the continuation of a widening spread. On top of that, today's trading session opened with a breakout gap that lead to testing the support and the Bollinger Ceiling. Price levels broke through the 50-day simple moving average which meets up with the Bollinger Top and the resistance level. These next few trading days will determine if the movement is a false breakout, but RSI shows no reason to think these companies as overbought. I expect a resistance turned support as well as a retracement of 50-66% of the losses sustained in the summer.

These three charts show a significant shift in the energy sector's main components, oil and gas related securities. Movement this week will help to differentiate between false signals and a true shift. Major changes from bearish sentiment to bullish mentalities might have to be supported by news reports that push prices higher. Look for rig data or earnings to set off a domino effect that could reverse the losses of Q3. After reviewing the data from that quarter, one could say the dismal performance was a contrarian indicator for the reawakening of the bulls. Nevertheless, economic recovery in China and emerging markets needs to remain on track for these major gains to breakout. If the institutional tide changes, investors could see high volume levels as the selling of old hedges is followed by the establishment of new ones. Going forward, both the firm and the individual trading oil and gas futures and futures related securities should remain aware of these bullish indicators and be prepared to react if these signals turn out to be robust bullish gains.

Sunday, October 4, 2015

Market Capitalization in the Energy Sector

Over the past couple posts, I've discussed various characteristics of the third quarter while often turning my nose up to their stinky trends. Particularly, energy sector performance was looked at and compared using some oil and gas companies as well as the major S&P Energy index. The red numbers hadn't been that bad for some time, 7 years that is. Wasn't the period after Lehman's fall supposed to be full of gains following the recession? In fact it was in the first half of the 2015 year, the Dow Jones Industrial Average reached a very high (and perhaps exceptionally capricious) 18,000 points. If it weren't for poor statistics in the two largest world economies, bulls would be having a heyday with a sharp rebound in crude oil and exploding equities. But it wasn't. Now in October, investors and the Fed continue to clamor about the tight money conditions and low inflation, and that affects everyone differently. Today, I wanted to take one more look into Q3 and investigate some small-cap, mid-cap, and large-cap differences in the energy sector.

Using a list of 352 energy stocks compiled by NASDAQ, three stratified random samples of 20 companies will be taken. These three samples will be split up into small-cap stocks, mid-cap stocks, and large-cap stocks before the sampling process in order to establish randomization within the groupings. Large-cap stocks will have market capitalizations of $8 billion or higher, mid-cap stocks will have between $8 billion and $1 billion, and small-cap will have less than $1 billion. Looking at the mean Q3 losses, the performances of large, mid, and small market capitalization stocks can be compared and analyzed further. The third quarter time period will be measured as 65 days between June 30, 2015 and September 30, 2015. Here is the data from the stratified random sample separated into the respective groups:

2015 Q3  energy sector performance data

The first column classifies the market cap, and the second column specifies that number. The last column lists the third quarter performance of that data point in a percentage. As a list, the data provides very little insight into a comparison so let's organize it:

2015 Q3 energy sector performance boxplot

Above, a boxplot was created to organize the data and characterize its spread using one variable summaries. Looking first at the means calculated using performance data, one notices a consistent improvement with market cap. Each classification is separated by about 10 percentage points. Small-cap energy stocks performed the worst with an average of -36.40% lost in the third quarter. They also had the highest variability in their data as the standard deviation fell just below 18%. Mid-cap stocks and large-cap stocks both had similar variation with similar standard deviations, but mid-cap stocks performed 8.3% worse on average. Even without the large-cap outlier at 15.85%, the new large-cap mean at -18.72% was 8% better. Median data tells the same story. The 50th percentile from each classification differed less than 1.9% for each respective data as most of the data shows a unimodal pattern with very little skew. The only outlier was the large-cap stock Tesoro which was the sole gainer out of this sample. Except for the outlier, the showed systemic similarities on most of the observed statistics. Small-cap energy stocks had the biggest loser, and large-cap stocks had the highest gainer. A couple days ago, an article looked at the S&P Energy index for Q3 which performed at about 18%. If a portfolio were to use my random sample of large-cap energy stocks, they would have performed at about the same level (give or take 0.5%). On the other hand, no mix of energy stocks would have had a very good chance of beating the market average, unless an expert had some good luck or inside information. The losing mid-cap and small-cap Q3 averages show the risk premium of taking on undervalued stocks, especially in a time where the respective commodity price is dangerously low and global economic conditions are sluggish. At the same time, the high variability in the small-cap statistics suggests that the performance varies and growth can be found to match or beat market averages (but is very rare). Mid-cap stocks which are typically safer bets performed about 9% worse than the S&P on average, but its middle 50% beat the small-cap stocks' middle by 10. At the same time, the bottom 75% of the mid-cap sample performed worse than the S&P average. Company's between $1 billion and $8 billion have the potential to perform well in tough times if they can show the liquidity to cover revenue losses. Having solid assets and a more established portfolio could be the reason for mid- and small-cap performance differences. The onset of demand worries which appeared late into the supply glut may have been the reason why mid-cap stocks couldn't compete with large energy corporations. Establishment and assets shouldn't be what separates a large-cap stock, instead, a successful, dominant firm will show its ability to survive through large cash flow and razor-thin profit margins. As the supply glut and weak demand developed, beating the market average became increasingly harder with the accumulation of bearish sentiment surrounding the energy markets. As one can see, the top 40-45% of large-cap stocks either beat or performed at the S&P averaged. The top 25% beat it by at least 4.4. Those statistics speak to the ability of large-cap stocks to control the market and manage losses with expert leadership, but those attributes don't shield them from extreme losses. The variability in large-cap data was very similar to mid-cap losses, and the bottom 25% performed at 9 below the S&P average in the random sample taken.

2015 Q3 energy sector performance scatter plot

The last thing to look at with the given data is a scatter plot depicting a correlation between 2015 Q3 Performance and the Market Cap of the respective energy stock. The x-axis was transformed into a log scale to show the exponential connection between performance and market cap related to the third quarter. The data show a slight positive correlation between the variables with two obvious outliers. Using the lines to differentiate between small-, mid-, and large-cap, one can see the large amounts of space between market caps below $1 billion representing the variability existing in small-cap data. Above $1 billion the spreads between the data points and the line of best are smaller showing less variability. It may be cliche of me to say, but smaller companies have shown that they perform inconsistently during tight economic periods. Investors are not willing to bet on the higher probabilities of bankruptcy as a result of the premiums on borrowing that nubile firms need. Portfolio managers, may this be a warning to abandon small-cap as oil prices and demand falls because of uncertainty in that arena. On average, a randomized selection of mid-and large-cap stocks will perform better with less risk and less variability. Randomly selecting large-cap stock is safer still, although, it may be more expensive to diversify. The potential of Q4 might propose decisively different results for these groups through the next three months. Oil prices should see a net increase after a 24% decrease in Q3. Small-cap energy stocks may see a huge rebound if earnings turn out better than expected, and mid-cap energy may see that jump as well. Large-cap stocks will have a more muted rebound because of their naturally low beta, but as the cost of borrowing goes down once more, look to see expansive buying to take place as high margins free up cash for asset purchases.

I'll be looking forward to a more prosperous fourth quarter as I move away from third quarter analysis. Next up is the earnings season where oil and gas companies get to see how much the price has hurt them compared to their competitors. It is finally time to see the bottoming out of the supply glut.