WTI Oil Down - This Is Still A Correction
Before we talk about how the WTI Oil Down is affecting the market, let's first review the market. The stock market rallied on Wednesday. With this rally, much of the correction has been rescinded. It was never deep to begin with. The same recession risks are still out there. We did get a very strong non-manufacturing ISM PMI reading.
These types of data points muddy economic analysis. It’s very rare for all the data points to head in one direction. We’re in a slowdown not a recession. The only time all the data points were aligned in recent history was during the 2008 recession. That ISM report doesn’t change my opinion that this rally is a blip. The oversold market catalyzed it.
Specifics Of Wednesday’s Rally
WTI Oil Down - S&P 500 increased 0.82%, Nasdaq increased 0.64%, and Russell 2000 fell 0.12%. S&P 500 is only down 4.06% from its record close. This equates to a 15.6% chance of a recession. There aren’t many models showing that low of a recession risk.
You don’t need to believe there will be a recession this year or next year to sell stocks. Personally, I wouldn’t make a bet against stocks if that was the scenario. I think there is close to a 50% chance of a recession in the next year. This slowdown is almost as bad as the one in 2016 and the yield curve is more inverted.
VIX fell 5.19% to 16.09. I think this a great time to bet on the VIX. The oversold rally is almost over, if it’s not already over. This rally pushed the CNN fear and greed index up 3 points to 29 which is fear.
While the market isn’t exactly overbought, it’s not supposed to be overbought in a correction. Especially one catalyzed by weak economic data and a trade war. The median of 11 estimates has Q2 GDP growth at 1.7%. ECRI leading index’s yearly growth rate is negative. And Q2 S&P 500 EPS growth is expected to come in at -0.22%. With much of the yield curve inverted, that’s not a recipe for an overbought market at its record high.
WTI Oil Down - Every sector rose on Wednesday except energy.
Energy fell 1.08%. As you can see from the chart below, WTI oil is down 18.6% in the past 10 days. That’s one of the worst 10 day declines in the past 10 years. Oil investors know that the global economy is weak. They read the May Markit global manufacturing PMI report.
Global PMI fell from 50.4 to 49.8. This was the worst reading since October 2012. New orders fell from 50.1 to 49.5. Anything below 50 means the category is in decline. Future output index had the biggest decline as it went from 59.9 to 58. Global PMI fell due to the big decline in the U.S. PMI.
Best 2 sectors on Wednesday were the utilities and real estate which increased 2.14% and 2.33%. That’s a signal this rally is almost done. Those are defensive sectors. After falling 3.24%, the utilities sector is at a new record high. It is up an astounding 15.63% year to date, while the S&P 500 is up 12.74%.
Fed Describes Worries About Trade War In Its Beige Book
WTI Oil Down - In the Fed’s Beige Book report, it stated there was a slight improvement in economic activity from April through mid-May. It described growth as modest.
Fed showed in its projections in March that it expects long run GDP growth of 1.9%. Therefor, the 1.7% growth rate expected by analysts in Q2 isn’t a disaster. It’s not great when you compare it to the numbers from 2018. But it’s not recessionary.
To be clear, a recession is when growth is below the long run trend. That doesn’t mean there needs to be negative growth. However, since long run growth is so low, a recession probably would have negative growth.
For the global economy that’s not the case as its growth is higher.
WTI Oil Down - Specifically, the Fed described the St. Louis district by stating, “Contacts in the corrugated packaging industry reported slow growth attributed to the current trade dispute with China.”
Minneapolis Fed described its district’s economy by saying, “Several contacts indicated a down shift in demand growth if there is a not a resolution to the trade dispute with China, although a few were optimistic that an agreement would be reached and benefit the U.S. long term.”
Finally, the Fed described the Cleveland district by saying, “Many contacts are concerned that the increased tariffs on goods traded with China will further exacerbate softening manufacturing activity in China, leading to less demand for American products from Chinese manufacturers.”
It’s no surprise businesses are telling the Fed they are worried about the tariffs. That’s what they mentioned in the ISM manufacturing report. Businesses are pulling back, mostly because they are uncertain.
Rate Cuts A Guarantee?
WTI Oil Down - As a reminder, the June 19th Fed meeting includes economic projections. Fed will give specific guidance on rates and the economy like it did in March. Only Fed member who floated rate cuts this week was Bullard. And he’s widely considered to be a dove.
The Fed has done little to assure investors a rate cut is coming. Yet the Fed funds futures shows there is a 94.5% chance the Fed cuts rates by September. There’s even a 25% chance the Fed cuts in June, which I think is highly unlikely.
It would take a terrible BLS report on Friday to make the Fed consider cutting.
WTI Oil Down - Conclusion
The stock market isn’t pricing in a recession. But the Fed funds futures market expects 2 cuts this year. If the Fed cuts rates and ends the slowdown, this would be an unusual cycle. Recently rate cuts have preceded recessions. I think the best way to avoid a recession would be making a trade deal with China at the G20 summit.
If we knew new tariffs were going to be added in the next few months, I’d say there is about a 60% chance of a recession in the next 12 months. Obviously, if you think more tariffs are coming, you should short stocks.
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