Stocks finished mixed Thursday as oil prices plunged another 3.8% to test the $74 a barrel level for the first time since 2010. On the surface, cheaper oil seems like it would be a great thing. And certainly, it’s going to provide a boost to American workers still waiting for a healing job market to generate an increase in wages.
But the collapse in energy prices, with oil down more than 30% since June, is raising worries that it reflects growing deflationary pressures from weakening economies in Asia and Europe. And as you can imagine, that’s not a good thing. This has been corroborated by the drop in copper (which is colloquially known as “Dr. Copper” since its price movements are said to predict changes in the economy) and other industrial commodities.
In the end, the Dow Jones Industrial Average gained 0.2% to nip a new record high but the Russell 2000 lost 0.9% for the worst decline in this collection of small caps in three weeks.
On the back of the latest drop in crude oil, which is now falling at its fastest rate since the financial panic following the collapse of Lehman Brothers, sector level activity was very dependent on the winners and losers of cheaper energy. Airlines got a lift, with United Continental (UAL) up nearly 4%. But oil and gas stocks were hammered, with the Energy SPDR (XLE) down 1.3% with smaller names like Schlumberger (SLB) suffering more, losing 2.7%.
The evidence continues to grow that market insiders are preparing for trouble with big catalysts such as a possible showdown between President Obama and Congressional Republicans over the continuing budget resolution early next month as a consequence of expected executive action on immigration. The situation in Ukraine is also heating up, with ongoing reports of Russian troop movements into the area.
For the third day, the CBOE Volatility Index, or VIX, decoupled from the stock market to move higher as options traders bid up put option protection against declines in share prices. Small caps also are hitting resistance from their early September highs and are vulnerable to a pullback here as market breadth continues to disappoint: Despite the S&P 500 hitting a new intraday record today, less than 70% of the stocks in the index are in uptrends, down from 77% in September and 85% back in July.
At the same time, bullish sentiment is off the charts while the market’s persistent rise out of the Oct. 15 low looks increasingly anomalous. Consider that today marked the 20th consecutive session in which the S&P 500 finished above its five-day moving average. That’s only happened three other times in the last 20 years.
And each time, when the moving average was broken, a wave of selling pressure was unleashed including a near 15% drop over six weeks in 1996.
In response, I’ve recommended Edge subscribers prepare for a downside move via a position in the leveraged VelocityShares Daily 2X VIX Short-Term ETN (TVIX), which is up 3.3% since Monday.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters, as well as Mirhaydari Capital Management, a registered investment advisory firm.
