Crude oil could be bad news for stock bulls

By David Nelson, CFA

Health care and the French elections topped the “wall of worry” list for the last several weeks. After the Macron win, health care is once again center stage, as a partisan Congress deals with the AHCA. Politics aside, the bigger concern for investors is tax reform slipping to 2018, as the health care debate sucks up all the oxygen in the room.

Can the hammer save oil bulls?

Crude oil is forming a tenuous bottoming pattern. (Source: Bloomberg)
Crude oil is forming a tenuous bottoming pattern. (Source: Bloomberg)

Lost in the noise and near-hysteria in the press, investors are once again are face to face with a familiar nemesis. Plummeting oil and the baggage that comes along with it is back. Some of the biggest throwbacks in the market have come on the heels of falling oil, as investors start to question economic growth. As the decline accelerates, the financial sector comes into focus with concerns mounting over just how much energy exposure banks have on their loan books.

It’s different this time?

Can stocks continue to move up if oil moves down? (Source: Bloomberg)
Can stocks continue to move up if oil moves down? (Source: Bloomberg)

Investors know all too well the damage the falling commodity can have on investor returns as some of the issues mentioned above play out. However, for the last few weeks, stocks and oil have been heading in opposite directions as the high correlation morphed into an inverse correlation.

The most recent slide in crude started on April 12. On an intraday basis during Friday’s session, the commodity was down over 18% in just a few short weeks. Oblivious to the slide or looking at the bright side of reduced energy prices, stocks started a slow climb north, up well over 2% during that time frame.

Friday’s session gave oil bulls a glimmer of hope. After hitting lows for the year, crude staged a comeback forming what market technicians call a “hammer,” a bullish reversal signal often seen in downturns.

Given that the world is currently flooded with oil and production here in the states continues to ramp up, it remains to be seen if it can hold these levels—much less climb from here.

S&P 500 makes a new all-time closing high. (Source: Bloomberg)
S&P 500 makes a new all-time closing high. (Source: Bloomberg)

At least for now, investors are focused on the 13% earnings growth in the first quarter while ignoring the weakness in crude and some of the soft macro data. In addition, a major bright spot this quarter was signs of real revenue growth—something absent in the last few years, as CEOs focused on boosting earnings per share through financial engineering.

Let’s hope last week’s modest push to an all-time closing high in the S&P 500 (^GSPC, SPY) is the beginning of a new trend and not the end of old one.

*At the time of this article some funds managed by David Nelson were long SPY


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