This has been another week of, hopefully, once-in-a-lifetime market events. Today’s update will be focused on answering your questions about the surprises in the oil market on Monday and Tuesday and how earnings data is affecting our strategy.
From a technical perspective, seeing some profit-taking at this point isn’t a surprise. The S&P 500 nearly reached its 2,890 inflection point, which is roughly even with the catastrophic gap that opened on March 20, the day Goldman Sachs (NYSE:GS) warned that U.S. gross domestic product (GDP) was likely to drop 24%.
Daily Chart of the S&P 500 (SPX)
Gaps to the downside create resistance, which increases the potential for large drops if bad news appears. And bad news showed up this week.
Oil at Negative Values
The issue of negative oil prices is a tricky one to explain. Unfortunately, you will not be able to pull up to the gas station and get paid to take gasoline off their hands. And while the collapse in the oil market will probably lower fuel prices, crude prices dropped so far and so fast that the negatives will outweigh the potential positives of lower costs.
You would not get paid for going out to buy a physical barrel of oil. However, the futures for May and June delivery did go negative.
That means investors who owned futures contracts — and were therefore responsible for accepting delivery of 1,000 barrels of oil per contract — were so desperate to avoid delivery that they were willing to take a loss of more than 100% of the notional value of that contract to get out of the trade.
The trigger for the collapse is a combination of the ongoing glut of oil production, full crude oil storage facilities, incredibly low demand for fuel and a price war between the Organization of Petroleum Exporting Countries (OPEC) and Russia.
The decline in oil prices led to a new multiyear low on Monday and Tuesday. Oil prices are sitting around the same price per barrel as they were in the late 1990s and during the dot-com recession of the early 2000s.
Daily Chart of Crude Oil Futures (CL1!)
Clearly, this is bad for oil stocks. The decline is also a huge problem for banks in the Midwest and Southeast U.S. where a lot of oil is produced.
Banks in these regions are at risk because they have very concentrated exposure to the industry in the form of loans to oil companies, oil-related employees and entrepreneurs and businesses tangentially related to the oil market.
We were shocked by the surprising buying interest in banks like Regions Financial (NYSE:RF) following their earnings reports. This may lead to some profitable short opportunities if the situation continues to worsen and banks are still overvalued.
A collapse in oil prices accompanied the last three major recessions — and 2015’s earnings recession. The most recent drop adds weight to our forecast that a prolonged bullish trend is unlikely to emerge until late summer.
By last Friday, 9% of the companies in the S&P 500 had reported earnings. According to Factset, the blended earnings growth rate, which includes estimates for companies that have yet to report, is -14.5%, which will be the largest decline on a year-over-year basis since 2009.
We contend that since companies are missing expectations to a much greater degree this quarter, we could easily break the 2009 record. When second-quarter earnings reports are released in July, we definitely expect the decline to break the record.
As you might expect, the energy and basic materials sectors are leading the contraction in earnings growth. Take for example, Halliburton (NYSE:HAL), the oil services firm.
The company reported earnings on Monday and had to resort to some extraordinary accounting to show a “profit.” While Halliburton’s adjusted earnings showed income of 31 cents per share, its non-adjusted or net loss for the first quarter was $1.16 per share. For perspective, HAL stock’s non-adjusted or net loss for the previous 12 months was $1.28.
As you can see in the following chart, the stock has seen a little extra buying interest, but we believe it is unlikely to break resistance.
Daily Chart of Haliburton (HAL)
However, there are some bright spots this quarter that are worth watching. As we wrote about three weeks ago, if companies are willing to provide guidance for future earnings — even if the outlook is negative — investors will likely perceive this as a positive for stock prices. Any guidance could help firm up support levels.
Texas Instruments (NASDAQ:TXN) reported earnings yesterday, and the company modeled its outlook using data from the 2008 financial crisis.
While we don’t think Texas Instruments’ approach will lead to an accurate forecast, this tells investors that management is willing to look towards the future, which is a sign of confidence. As you can see in the following chart, TXN stock is up 3% on the news, and we believe companies’ guidance is one factor that sent the market indexes higher overall.
Daily Chart of Texas Instruments (TXN)
The overall decline in earnings is bad, but it’s not evenly spread across all sectors. Additionally, the declines in earnings and commodity prices will keep inflation under control despite the flood of stimulus money from the U.S. government.
Consumer staples stocks, some consumer discretionary stocks and companies that provide business services — especially technology firms — are likely to do well relative to the rest of the market.
We don’t expect any breakouts, but stability within the current price channel will give us more opportunities to harvest covered-call premiums for income.
The Bottom Line
We expect the S&P 500 to test its March 26 high — around 2,630 — as a potential support level. We are prepared to roll our short-call positions out again if the market starts to gain some momentum at or around that level.
Currently, we are focused on only increasing our risk in groups or sectors that are showing relative strength, including consumer defensive, select consumer discretionary, packaging, and business technology stocks.
John Jagerson & Wade Hansen are just two guys with a passion for helping investors gain confidence — and make bigger profits with options. In just 15 months, John & Wade achieved an amazing feat: 100 straight winners — making money on every single trade. If that sounds like a good strategy, go here to find out how they did it. John & Wade do not own the aforementioned securities.