Crude Oil Collapse Crushes Stocks and Junk Bonds

It’s getting real now.

On Wednesday, the Dow Jones Industrial Average, S&P 500 and Nasdaq Composite each lost well more than 1%, while the Russell 2000 plunged 2.2%.

The smooth, seeming invincible market rise out of the Oct. 15 low is being replaced by fear, uncertainty, and the beginning of what could turn into panic as we head towards the end of the year. And with it, the dream of another prototypical “Santa Claus rally” is under threat.

Already, the NYSE Composite Index, my preferred stock market gauge, sliced below both its 50-day and 200-day moving averages in one fell swoop as it tips into a fresh downturn for the first time since September. The CBOE Volatility Index, or just the VIX, dubbed Wall Street’s “fear gauge,” increased nearly 25% today for its best one-day gain since the 2% market decline suffered on Oct. 9.

NYSE

After being lulled into a false sense of security back over the last three months — on hopes of more cheap-money stimulus from the major central banks — investors are suddenly contending with a growing list of problems.

At the top are the meltdowns underway in crude oil and the high-yield corporate bond market.

There are many moving parts in play, from wild stock market volatility in China to political drama and the worst stock market decline since 1987 in Greece. Japan is suffering currency volatility heading into snap elections after falling into a quadruple-dip recession on weaker-than-expected third-quarter GDP numbers. Plus we have the upcoming Federal Reserve policy meeting next week, with chatter circulating that the first interest rate hikes since 2006 could be coming within the next six months.

And there is a growing feeling that after hinting at a government bond purchase program for more than two years, the European Central Bank is about to get its bluff called as the Germans push back against efforts to try to paper over the currency union’s structural problems.

Like I said, there are lots of moving parts.

But above all this is what’s happening with crude oil and the impact it’s having on credit markets as fears grow over the solvency of deeply indebted, high-cost U.S. shale oil producers. Crude oil dropped below $61 a barrel, down 43% from its summertime highs, following a cavalcade of bearish headlines including higher-than-expected inventory builds, bearish comments from Saudi Arabia’s oil minister, as well as projections for lower oil demand in 2015 from OPEC.

Late in the session, there were reports that an emergency OPEC meeting, where a production cut could be made to stabilize prices, isn’t going to happen until the first quarter of 2015.

Translation: The meltdown in crude oil is going to continue for at least another month.

At first, the drop in crude oil was seen as a positive since it boosts consumer purchasing power. But investors now realize this is about to weigh on corporate earnings (given the S&P 500’s exposure to the energy sector), GDP growth (given the energy sector’s importance to overall capital expenditures), and the credit markets (given that high-yield borrowing has become increasingly concentrated in shale oil producers over the last few years).

JNK

The result of this realization can be shown in the chart above of the Barclays High Yield Bond ETF (JNK), which has sliced into the red year-to-date after returning to levels not seen since last December.

Investors weren’t prepared for this, with sentiment and positioning data at multi-month highs. This was a mistake, and will likely lead to continued declines, given the slow deterioration in market breadth — or the number of stocks participating to the upside — that I’ve been warning about for months.

In other words, as long as crude keeps sliding, this downtrend is likely to get worse. Much worse. Especially if, as expected, the Fed tees up rate hikes for the first half of 2015 at its meeting next week.

In recent days, I’ve highlighted the weakness developing in popular technology stocks such as GoPro (GPRO) and Tesla Motors (TSLA) — you can see my list posts here and here — and have recommended Edge Pro subscribers move in with December put option positions.

GPRO

The TSLA $230 puts recommended on Dec. 3 are up 180% while the GPRO $70 puts are up 81% since Monday.

Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters.

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Article printed from InvestorPlace Media, https://investorplace.com/2014/12/stocks-junk-bonds-crude-oil/.

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