The last few days have seen big drops in both stocks and oil. The Nasdaq had, at one point today, lost over ten percent in three trading days. The Dow and S&P weren’t hit quite as hard but are also down significantly. WTI crude futures, as represented by the futures contract CL, have done even worse. At one point today that market was down over sixteen percent from last Wednesday’s opening.
Of course, that is all history now, but it raises two questions for traders and investors. Could you have seen it coming, and will it continue?
The answer to the first is a lot clearer than to the second. Yes, you could have seen it coming if you were paying attention to crude. That isn’t 20/20 hindsight either. I made just that call last week in two separate places.
Last Wednesday, I was speaking in the DTI Trade Room, a subscription service where I and some other traders hang out and offer advice and ideas to subscribers, when I pointed out that oil was about to challenge its 50-Day Moving Average (MA). If it broke that, I said, the bottom of the long-standing channel would be in range and if that broke it would trigger a lot more selling. All of that, I said, looked extremely likely at that point.
Here’s what the chart for CL looks like now, three trading days later…
The next day, based on the same analysis, I sent an e-mail to Energy Income Trader subscribers, recommending that they also short the S&P 500 through selling the E-Mini futures contract, ES.
Here’s that chart…
I mention all this, not to suggest that I am a genius, (although if you want to come to that conclusion, who am I to stop you!), but to point out that this move wasn’t as shocking as some people seemed to think. It shows the importance of following oil, whether you trade it or not, as it can often be the canary in the coal mine, giving early warning of stock market moves.
Also, of course, if you are not subscribing to Energy Income Trader, you are missing out on some trade ideas and strategies that have been working pretty consistently since we launched the service. If you had shorted 1 ES contract on Wednesday when I first suggested it, you would be showing a profit on that one trade of just under $10,000 now. Not bad for a $99/Year subscription!
If you are interested, click this link to get started.
Anyway, that still leaves the question of whether there is further to go in this drop.
If you follow the logic that led to my original call and look again at the CL chart above, you will see that we are close to a level that will be a big factor in whether or not we do go lower still. The yellow line on that chart represents the 100-Day MA. That is next major support on the chart, so could be seen as the next big challenge for traders. It might not work out that way, however.
My call on Wednesday and Thursday was based on my experience in a dealing room. I knew that after such a long period of relative inactivity in crude, the approach to two critical support levels so close together would be seen by desk traders as a challenge more than anything. If conditions were weak enough to get that close to the levels, they could be used as an excuse to crash through them by some traders who felt a bit starved of action.
That is what we got.
With that itch scratched, though, the 100-Day MA may not be quite so tempting. To get through that, there would have to be a real shift in the fundamental outlook. So, how do things look?
The demand picture for oil has been shaky for some time now, but the reduction in U.S. supply that came with the collapse in price has continued and has more than offset that dynamic.
That demand outlook from here looks weak too, especially as the summer driving season comes to an end. But as I said, that is nothing new. For a break of the 100 MA there would have to be real signs of increased supply to go with that drooping demand, so you should keep an eye on the North American rig count released by Baker Hughes each Friday, and on any news about compliance to output restrictions by the participants in the OPEC+ agreement.
Without big changes there, it would be no surprise if the 100-Day MA held.
Even if oil steadies though, stocks can still head lower.
First, they went into this way more overbought than crude. Earnings multiples were looking stretched even before that latest damp squib of an earnings season. You may point out that there were a lot of beats of expectations over the last couple of months but then there always is, and Q2 earnings were down over 35% from the same quarter last year. That makes it hard to justify record highs and is a massive increase in overall P/E.
A correction was overdue.
Second, if you look at the chart for ES, you will see that it is now in a similar place from a technical perspective to where crude was last week. We are approaching that 50-Day MA, marked by the blue line, and a crack at it may just prove too strong a temptation to be avoided in the circumstances. If we do break it, the next stop would be the 100-Day, leaving room for significant further losses before any technical support.
So, while it is quite possible that both continue lower, it is more likely that stocks will do so, whatever happens to crude. Oil has to get through the barrier of the 100-Day MA, while S&P futures are poised just above a 50-Day that looks more like a target than a support. The bounce off of that level that came overnight is natural. What matters is what happens from here, and another crack at it has to be a possibility.
If you aren’t short yet, there may be a chance to make some money selling S&P futures on the bounce, or, if you don’t play futures, buying a leveraged bear S&P ETF. I would, however, wait for a roughly 50% retracement of the bounce before doing so. If you are an EIT subscriber and are already short both, you are obviously in a much better position. You should watch the two in-target MA supports. If either break, reset your stop just above that level in anticipation of a sustained move lower.
If, on the other hand, either or both holds, the take it as a signal that the move down is probably over, take a nice profit and think again…