Global downside pressure on markets and oil production cuts make headlines.

The downside opened up in equities this week, as we saw Friday’s crack of key support on to the S&P 500 open some room for sellers to take the US equity market down to the 2018 lows. The week started off on weakness as Theresa May pulled the Brexit vote and the S&P 500 dropped under its October lows for the first time. May just barely made her party’s confidence vote, but there is little clarity on the future of Brexit and her current position.

Trade news helped the downside open up as well as a ban on certain iPhone imports and sales were banned by a Chinese court. Off the back of that news, midweek there was hint at easing of trade tensions between China and the US which saw a bid in US equities. The downside was ever present and a bid could not be sustained whatsoever, even with the announcement of a temporary ease in auto tariffs out of China. From what it seems, the downside on equities overshadows even the good news.

The ECB President Mario Draghi hit the wire late this week, outlining an indefinite reinvestment process. Draghi confirmed the ECB’s dovish position addressing the possibility of future rate hikes. In which he said were far away, however he also mentioned a lowered expectation of growth prospects.

The drop into the close of the week was helped by the deterioration of global data and crash warning signals. Manufacturing data out of France is reaching contraction levels, while EU PMI missed. The EU and Italy are slowly moving towards a 2019 budget. In other global news, China and US are still going back and forth, rendering the words at the G-20 dinner meaningless. The Chinese economy is dropping directly due to US tariffs, which helps US leverage, pressing China into a deal. Chinese retail number are growing at very slow pace, a pace that has not been seen since 2003.

Here is a look of last week’s stock market on a daily basis (red vertical lines split days).

Stock Market and Sector Overview

Here is a break down of the weekly performance in various stock market sectors (top chart):

  • Energy stocks down 2.75%
  • Technology down 0.23%
  • Financials down 3.19%
  • Retail down 3.91%
  • Utilities up 0.91%

Overview of key markets last week (bottom chart):

  • Crude oil down 2.31%
  • S&P500 down 1.25%
  • Silver was down 0.41 %
  • Gold down 0.91%
  • US dollar up 0.87%

Downside in the American economy-led by US equities and Yield inversion.

US equity markets are struggling to maintain any bid as the sellers come in to sell the rip over and over again this past week. Strong volume comes in on the downside to press price lower. Some may be thinking, does TRADEPRO hate the markets? Why all of these “worst case scenario” blog posts? That is not the case, we are just showcasing all the signs! We want to educate the public and save capital. There is however more downside to come out, and this may just be the beginning.

First, the flattening of the yield curves has been in the works over the past few months, and as one knows the inversion of the yield curve in a sign of a recession. Why is that though? The simple answer is that out financial systems, in banks continue to make some of their money by lending long and borrowing short. The inversion of the yield curve is when short term rates exceed long term rates. This inversion causes banks to lose the ability to make money how they normally do. This causes banks to be able to lend less money.

Reuters forecasts a inversion in the yield curve in early 2019, and a recession to follow within a year after that occurs. They predict a rise of the 2-year T-yield to reach the 3.20% level within a year, current level around 2.75%. While the 10-year is expected to each 3.30% in the same amount of time from 2.90%.

The chart below represents the 10-year and 2-year spread from 1975 to present date, December 2018. The black horizontal line in the middle represents the 0.00% mark under which is considered an inversion of the yield curve. Currently, rate inversion is dangerously close, the spread being at 0.16%. Its evident on the graph that the inversion in previous years has been accompanied by a large market crash and a recession.

The 2-10 year spread. Source: FRED

The rest of the points in this article might be unexpected but rest assured they have a huge impact on the potential downside of the global economy, and the US stock market.

The next portion outlines north american housing prices and personal income levels. To start it off, over the past 12 months, about 62% of Americans did not receive a raise or a better paying job. While 27% received a raise, 6% a better job and 5% both. Compared to last years 52% who did not receive either a raise nor a better paying job. Some average waged Americans have been at their current salary level for 3-5 years, while cost of living increases, salaries do not. Numbers of people who received a raise or a better paying job are down as well. Conversely, the rich get richer, as average CEO earnings at the largest 350 US companies received a 17.5% pay increase. The average taking home about $19 million. The increase in the economic growth does not correlate to the output per hour of work employees are doing. The increased cost of living account for only 27% of raises over the past year. The difficulty to earn a respectable living to get a house and start a family is overwhelming in today’s younger America. This is reflected in recent falling housing prices in both Canada and America.

In areas such as New York and Vancouver, a recent drop in housing prices has overwhelmed many, because no one wants to buy, or can afford to for that matter. Renting is the way to go it seems. “Years of price appreciation, combined with caps on property tax deductions and rising rates are all guiding prices lower and slowing the market down” says Chief economist Greg Heym of Terra Holding. In some areas of the US, there has been a huge slow down but in more a stall in appreciation and that is a signal. The well documented Vancouver housing market (leading indicator) is under fire again as home sales drop to a 10 year low, prices falling 8.5%, the biggest hit since 2009. In contrast Canadian unemployment (lagging indicator) dropped to a 42 year low this year. One can consider the housing drop in North America a recession warning sign. The Canadian 2 and 5-year curved inverted along that of the US for the first time since 2007.

Our final piece of evidence is a very important chart that should be revisited time and time again. Below is the SPX and the 10-year US yield graph, the SPX being on top. Both are on a weekly time frame. Keep in mind that lines on a chart can easily be erased so one should take this with a grain of salt. However these charts suggest the break of two very important trend lines. First the SPX. The exponentially accelerating upside since 2009 has broken before when we had a market crash scare, in the summer of 2016. This time around, there is a move into the trend line as support, with a potential breaking opportunity. On the other hand, looking at the US 10-year yield the channel is broken to the upside, each time the yields press against the upper channel resistance there is threat of a crash, or a crash, this time around the break is evident.

SPX vs 10 Year Yield

Oil productions cuts, will they actually happen?

This past week there was talk of production cuts from both Saudi Arabia and Russia. Which sustained a partial pop in Crude oil futures, but the downside continues to be the right side as that news had little to no effect on the crude oil WTI price. President Trump did not keep his mouth shut on recent oil export cut news. He is still a strong advocate of low oil prices, and seems to consider anything about $60.00 artificially inflated.

However, Saudi Arabia has not yet confirmed the export numbers but it is expected to hit a near 30-year low of 582K barrels a day exported to the US, a drop of nearly 40% from the last quarters average. Venezuela has also removed 296 million barrels from the market over the past year, since the OPEC supply agreement began, surpassing Saudi Arabia’s 292 million. Ultimately effecting the price and not complying with the agreement. Russia too is looking to cut exports but not as much as Saudi Arabia has suggested. Saudi Arabia wants Russia to cut 250-300K barrels per day, however Russia insists only complying to only half of that.

Below is a crude oil futures chart. We’ve split it up in three, each represent a different time frame. The largest chart on the right is a daily time frame, the two on the left are a 4-hour (top) and 1-hour (bottom).

Based on the daily, crude oil has exceeded bear market territory dropping over 30% from the top of the recent move in November. The top of the move was $76.90, crude is now trading at the $51.20 level, $25.70 lower. Price has broken well below the two strong trend lines to the upside. On the way down on a intraday time frame, oil price behaved systematically printing a sideways range before dropping and it followed that pattern a few time before dropping into the low $50.00 level. This can be seen on the 4-hour chart, outlined in the red boxed. What is interesting to notice is that since late November through December, a larger sideways range began to form. This area of consolidation has been a lot longer than previous ones that led to substantial drops. Currently there is a lot of talk of production cuts and export cuts which, in theory, should help the oil price upside. However the bulls are struggling to take it up on bullish news.

The 1-hour outlines the current range between $50.10 to $54.15. A break of either of these levels will open up a lot of stops to either side. The next logical level for the bears is $49.00 to $49.10 and the next level for the bulls is $54.95 to $55.05. The real test of these levels is if OPEC and non-OPEC can agree to a certain level of production and adhere to it. The current proposed cuts are not influencing markets as much as some might have hoped, this is the real test, we could see a temporary bottom if oil producers cooperate.

Weekly Economic Calendar

Here comes another news event filled week to wrap up 2018, there are only a handful of trading days to close out the year, and it does not seem as the volatility will subside into the close. The beginning of the week will be a quiet one, but the rest of the week presents us with ample intraday opportunity.

Monday, no high impact events.

Tuesday, no high impact events.

Wednesday, CPI data out of the UK and Canada pre market. Then the big news comes out on the day the much anticipated FOMC meeting minutes and potential rate hike out of the US. The closes out with news out of New Zealand and Australia (employment numbers). Japan comes out with its policy rate and monetary policy statement that can shake up the yen.

Thursday, news out of the UK on retail sales, and monetary policy along with a bank rate vote.

Friday, news out of the UK, Canada and the US pre market surrounding GDP numbers and the BOC business outlook survey.

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