Wall Street was hit again on Tuesday after crude oil fell to fresh seven-year lows, slamming energy stocks hard. The Energy SPDR ETF (NYSEARCA:XLE) touched lows not seen since late September down nearly 17% from its early November high.
There was also chatter of the pressure building on the high yield junk bonds of many vulnerable U.S. shale oil producers, and the likelihood of an increase in debt defaults. Bloomberg reported that the average yield on speculative-grade oil and gas bonds has climbed to 13.4%, the highest level since the financial crisis.
In the end, the Dow Jones Industrial Average took a 0.9% dip, the S&P 500 lost 0.7%, the Nasdaq Composite stumbled 0.1% and the Russell 2000 ended the day 0.4% lower. Treasuries were little changed, the dollar weakened, gold lost 0.1% and oil dropped 0.1% to close at $37.63.
Materials and energy stocks were among the laggards, down 1.9% and 1.5%, respectively. Healthcare outperformed thanks to a rise in biotech stocks, gaining 0.2% as a group. Southwest Airlines Co. (NYSE:LUV) lost 9% after lowering its fourth-quarter revenue guidance.
The fear in the air was palpable, with the VelocityShares 2x VIX (NASDAQ:TVIX) recommended to Edge subscribers gaining 5.6% to bring its month-to-date gain to 10.3%.
Investors are reacting to the decision by OPEC oil ministers on Friday to continue their market share price war against U.S. shale producers by holding current production near their 30 million-barrel-per-day quota that’s been in place since 2011. In early trading, West Texas Intermediate fell to touch $36.60 a barrel — a level not seen since early 2009.
The bad news: The weak energy/weak stocks dynamic looks set to continue. Officials from Indonesia warned that an emergency OPEC meeting would need to be held if oil prices fell below the $30-a-barrel level. Until then, a change in strategy is unlikely.
Moreover, while OPEC’s official ceiling is around 30 million bpd, Oil Market Intelligence reports that they actually produced at a near-record pace of 38.8 million bpd in October at the same time non-OPEC producers pumped a record 57.2 million bpd. Poorer OPEC countries are being forced to pump more oil, despite lower prices, to try to help minimize the overall hit to revenues.
Similarly, weaker U.S. shale producers are being similarly forced to pump more oil at lower prices to try to raise the liquidity they need to service their debt load.
While U.S. drilling rig counts have fallen, U.S. shale producers have refocused on low cost/high productivity wells to keep production relatively stable. Offshore production, on the other hand, is actually rising according to the U.S. Energy Information Administration since they are driven by the desire of oil companies to complete these complex and costly wells once they’ve begun.
With manufacturing activity slowing globally and here at home (with the ISM Manufacturing Activity Index indicating activity is falling outright at its worst pace since June 2009), the world is simply awash in too much oil. It’s simple supply and demand. And until OPEC cuts production, or a wave of defaults and bankruptcies hit the U.S. oil patch, it’s only going to get worse.
With prices so low, global oil revenue is collapsing, down 56% from last year’s peak according to Yardeni Research — from a $3.8 trillion annual rate to $1.7 trillion. That will continue to weigh on the earnings of energy companies like Chevron Corporation (NYSE:CVX), which reported a 37% year-over-year drop in revenues back in October.
Already, according to FactSet, fourth quarter S&P 500 earnings are expected to decline 4.3% over last year in what is set to be the third consecutive quarter of declining profits. This is something that hasn’t happened since 2009. Energy sector profits are expected to decline 65% over last year.
Back in September, the overall expected Q4 earnings drop was just 0.6%. No wonder investors are fearfully selling stocks.
In response, I have recommended a new put option position against CVX to my Edge Pro subscribers ahead of an anticipated decline in the stock price to $83 — enough for a quick double in the options.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters. A two-week and four-week free trial offer has been extended to InvestorPlace readers.
