foxex: All Eyes Start Shifting to the Fed

Focus on the Price

Thursday, December 13, 2018

2. Bulls looking for safety in utilities

3. Oil prices could find a base from production cuts

Major Moves

Wall Street appears to be content with consolidating for a while before deciding whether to commit itself to increased bullishness or resign itself to a bearish pullback.

The S&P 500 finished the day virtually flat, down 0.02%, while the Dow Jones Industrial Average managed to eek out a gain of 0.29%. Tech stocks on the Nasdaq dropped 0.39%, but all in all, it was a fairly boring day for the major indexes.

On the bright side, the day was relatively benign despite a few errant tariff comments by President Trump on Fox News, which might have otherwise sent the indexes back to support. However, at this point, the next Fed meeting is close enough that traders may be getting a little 'tunnel vision' and ignore most news until the statement is out next Wednesday.

Central banks have lifted the financial markets for years. Low interest rates, bond buying programs and lots and lots of jawboning gave investors the confidence they needed to continue putting money into the financial markets in the aftermath of the Financial Crisis of 2008.

Knowing that the accommodative monetary-policy environment couldn't last forever, Central Banks have started to slowly pull back the support they have been willing to offer. For instance, the Federal Reserve (Fed) started raising interest rates a few years ago, it stopped buying additional Treasuries and mortgage-backed securities and it even started to reduce the size of its balance sheet last year. Another hike next Wednesday is still priced into the futures market.

Interestingly, the Fed has recently indicated it may start being less aggressive with its interest-rate hikes. By next week, the Fed will have raised rates four times during 2018, but it may not be as active in 2019.

The European Central Bank (ECB), on the other hand, has been a little behind the Fed in its monetary tightening. It has kept interest rates low and has continued to add to its balance sheet by buying both sovereign and corporate debt during 2018. That all is changing.

The ECB announced today it will keep interest rates low at least through the summer of 2019, but it confirmed it will stop its bond buying program – known as quantitative easing – this month.

While the markets will miss the ECB's bond buying activity, the news that the Fed is likely going to stop hiking rates so aggressively coupled with the ECB's commitment to keep rates low through most of next year has given investors hope that economic growth won't be curtailed by constrictive monetary policy shifts.

Utilities

Traders are starting to hedge their bets by moving some of their money to the safety of Utilities stocks as the S&P 500 continues its volatile fluctuation. The Utilities sector tends to outperform other sectors during times of market uncertainty because of the stable dividends utility companies pay and the recession resistant revenue generation these companies enjoy. Consumers tend to pay their utility bills even during challenging economic times. Speculation that the Fed and ECB will keep rates relatively low in 2019 also inflates the value of those dividends.

Looking at a 5-minute intra-day chart comparing the SPDR S&P 500 ETF (SPY) – the blue line – and the Utilities Select Sector SPDR ETF (XLU) – the green line – you can see that Utilities stocks have been rising as the S&P 500 has been falling. The opposite is also true. As the S&P 500 has been rising in response to positive trade news coming out of China and increased hopes the Fed may ease up on its monetary policy tightening, Utilities stocks have pulled back as demand for the safe-haven has diminished.

The strengthening of this inverse relationship between the S&P 500 and Utilities stocks tells us traders are cautiously optimistic and want to maintain portfolio exposure to the equity market, but they are not willing to take on as much risk as they have been in the past.

Crude Oil

After falling more than 35% from a high of $76.90 per barrel on October 3, crude oil prices have found support just above $50 per barrel. That support appears to be strengthening.

Oil traders have been concerned about the potential of over supply in the market as estimates for the amount of oil still available in West Texas' Permian Basin continue to grow thanks to improved extraction technology and new geological studies.

Fears of "peak oil" – the estimated point at which oil production would hit its maximum and begin to decline – have all but vanished as the United States has officially become a net exporter of crude oil.

To counteract the increased oil production in the United States, Bloomberg is reporting that Saudi Arabia has plans to cut its oil production in 2019 again. This would be in addition to the cuts OPEC+ announced last week. While this could lead to further erosion of market share in favor of US, Chinese, and European producers, it may have a short-term positive impact on prices.

It's too early to tell what the long-term impact of a production cut like this might have on the market, but it seems to have provided a lift to crude oil prices today. Each bullish bounce up from $50 per barrel adds strength to the support level. The last time OPEC tried to influence the market like this, it took a few months before it seemed to have an effect so there may still be a waiting period for this one as support builds its base.

Bottom line: Traders are still bullish but very cautious

President Trump's statement that China's reduction on car tariffs doesn't go far enough might have been enough to send the major indexes back to support today. Traders--who are on a razor's edge--tend to overreact to tariff news. However, despite some back and forth, and out-performance in safety-sectors, the S&P 500 and Dow Jones Industrial Average were flat and slightly positive respectively at the close. Momentum is slow enough to make forecasts above resistance premature, but a little more good news could get prices back to the highs established on December 3rd.