The markets sold off hard as crude oil rallied to record prices once again. Adding to the sell-off was a worse-than-expected Core Producer Price Index report.
Why are stocks selling off as crude oil rallies? Here’s the thesis many are using, including myself: as oil goes up, gasoline also goes up and the consumer will get pinched (it is much more psychological than anything else). This increase in prices will cause the consumer (consumer spending makes up about 2/3 of GDP) to stop spending and the economy will slow. The slowing economy will also cause the dollar to decline further. The Fed will not be able to raise interest rates until crude oil prices stabilize.
The other side of this argument is that as the economy slows, demand and therefore prices for oil will decrease. However, the global demand for oil is far too great to be affected by the slowing American economy. Everyone is worried about the future supply of oil, not what is available today. People want to get their hands on oil now because it might not be available in a few years. This is why we see crude futures for 2016 delivery exceeding $140/barrel.
Now, back to the rally in crude oil fueled by predictions. Boone Pickens, a billionaire oil mogul, said in a CNBC interview he expects to see oil at $150 by the end of the year. Also, Societe Generale and Credit Suisse both increased their price targets for oil. Everyone seems to be following Goldman Sachs’ lead. Just the other day Goldman raised its target for crude to $141. I’m also following their lead because in April 2005 when crude was $50 per barrel Goldman said prices were going to $105 per barrel. They have been right all along and I do not see a reason to go against them.
Keep an eye on the dollar. It is quickly approaching its all-time lows once again. Everyone is talking about the dollar stabilizing and possibly rebounding as the Fed raises interest rates, but as long as crude continues to rally don’t look for a rebound anytime soon.
From Briefing.com, “The April Producer Price Index rose 0.2%, while [the] core-PPI, which excludes food and energy costs rose 0.4%. Economists expected the opposite, forecasting a 0.4% rise in PPI and a 0.2% rise in core-PPI. The difference in total PPI and core-PPI is largely due to a 0.2% drop in energy costs on a seasonally adjusted basis. On a non-adjusted basis, energy prices are up 2.9%.”
Today, the financials were weak again…
- AIG announced it will raise $20B worth of new capital; Merrill Lynch cut its earnings estimates for AIG; shares fell to a 10-year low
- Oppenheimer’s Meredith Whitney said, “the real harrowing days of the credit crisis are still in front of us and will prove more widespread in effect than anything yet seen.” Whitney cut earnings estimates for Bank of America, Citigroup, JPMorgan Chase, Wachovia, and Wells Fargo.
- Lehman Brothers cuts earnings estimates for Goldman Sachs and Morgan Stanley.
- Bank of America plans to sell $2.7B in preferred stock.
In earnings news…
- Hewlett-Packard reported earnings that matched its pre-announcement on May 13.
- Home Depot’s Q1 net income fell 66%, but was less than analysts predicted. However, shares of HD were down 5.5% on the day.
- Staples reported earnings that met analysts’ expectations. Its Q1 profit increased 1.5% while its revenue increased 6.4%.
- Target reported earnings that topped analysts’ expectations, but income was down from the same period a year ago.
- Saks missed analysts’ expectations and the CEO said the consumer is acting as if there is a recession even if there isn’t one.
In today’s down market, there were a few bright spots. The winners were the stocks/sectors that have a strong long-term theme. Oil and gas, infrastructure, minerals, agriculture were all relative winners as the market sold-off. Some of the material names – Alcoa and Freeport McMoRan – were off in the morning after a downgrade, but managed to recover as the day progressed. These sectors have been the market leaders the last 12 months and they will continue to be the relative winners.
DJIA 12,828.68 -199.48 (-1.53%)
Nasdaq 2,492.26 -23.83 (-0.95%)
S&P 500 1,413.40 -13.23 (-0.94%)
NYSE Volume 3,861,710,000
2-Yr Bond 2.34% -0.08
10-Yr Bond 3.78% -0.05
30-Yr Bond 4.53% -0.03
Crude Oil (June) 129.07 +2.02
Nat Gas (June) 11.365 +0.411
Gold (June) 920.20 +14.40
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