At the moment, the oil market is much like the famous quote from the beginning of “A Tale of Two Cities.”
It is a tale of two markets: the futures market for oil (controlled by Wall Street) and the physical market, which reflects the real-world demand for oil. Both factor in many dynamics inputs, notably whether we’re actually heading into a recession.
Which Tale to Believe?
The price of oil dropped by about $15 a barrel in a few days in the futures market, thanks to recession worries. That pushed the global benchmark Brent crude oil price below $100 per barrel for the first time since April.
However, in the real world, there is no sign of a slowdown in demand for oil. In fact, it’s quite the opposite.
Premiums for the immediate delivery of oil are at record levels. For example, Nigerian Qua Iboe crude oil was offered at $11.50 a barrel above Brent, while North Sea Forties crude was bid at Brent-plus-$5.35—both all-time highs!
Here in the U.S., WTI-Midland and WTI at East Houston traded in June at a more than a $3 premium to U.S. crude futures, the highest in more than two years. And though both grades of oil have since edged off those highs, they are still trading more than 60% higher than at the start of June. Continue reading "An Oil Stock to Ride Out the Looming Recession"→
Although trading last week was limited to four trading days due to a holiday weekend gold had a deep and severe price decline.
Gold lost approximately $74 in trading this week opening at approximately $1814 on Tuesday and settling at $1741 Wednesday. Last week’s price decline resulted in gold devaluing by 4%.
The Friday before last, gold opened above and closed below a support trendline that was created from two higher lows. The first low occurs at $1679 the intraday low of the flash crash that occurred in mid-August 2021. The second low used for this trendline occurred in the middle of May when gold bottomed at $1787.
Gold closed just below that trendline one week ago, however it was Tuesday's exceedingly strong price decline of $50 that accounted for two-thirds of last week’s price decline and resulted in major technical chart damage.
The primary force that moved gold substantially lower last week was dollar strength. The dollar index gained well over 2% last week accounting for over half of the price decline in gold.
Dollar strength was a result of traders and investors focusing on recent and future interest rate hikes by the Federal Reserve. Since March the Federal Reserve has raised rates on three occasions with each rate hike having a higher percentage increase than the last. The Fed raised rates by 25 basis points in March, 50 basis points in May, and 75 basis points in June.
Friday’s jobs report was forecasted to show that 250,000 jobs were added to payrolls last month. The actual numbers came in well above expectations with 327,000 jobs added last month. The unemployment level remained at 3.6%.
The fact that the actual jobs report came in above expectations strengthened the hand of the Federal Reserve to continue to raise interest rates substantially this month.
It is highly anticipated that the Federal Reserve will enact another 75-point rate hike at the July FOMC meeting. Before the Federal Reserve raised interest rates in March the fed funds rate was just ¼% or 25 basis points.
Currently, the interest rate set by the Federal Reserve is at 1 ½ % to 1 ¾. This would take the interest level set by the Federal Reserve to 2 ¼% to 2 ½%.
According to the CME’s FedWatch tool, there is a 93% probability that the Federal Reserve will raise rates once again by 75 basis points this month.
However, there are three more times that members of the Federal Reserve will convene for an open market committee meeting which leaves the door open for additional rate hikes. Because the Federal Reserve is data-dependent the number and size of the rate hikes will be based upon whether or not there is a substantial decrease in inflationary pressures.
That being said, it is most likely that this week’s CPI report will not have a dramatic impact on the Federal Reserve’s decision to raise rates as Chairman Powell and other Fed members have stated that the Federal Reserve will aggressively raise rates at the July FOMC meeting.
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This has been the stock market’s worst first-half in over 50 years with inflation serving as the main culprit and a slew of ancillary pressures from China’s Covid lockdowns and the Ukraine/Russia conflict.
Through the first six months, no sector has been immune from the breath and reach of this bear market. The S&P 500, Nasdaq and Russell 2000 are well in bear market territory at June’s end.
Risk appetite across the spectrum has been eroded. The crypto market has collapsed, traditional IPOs and SPACs have dried up and several commodities have collapsed as of late.
Despite this massive wealth destruction, strategists from major Wall Street firms are forecasting that stocks will recapture most of their losses in the back half of the year.
The S&P 500 is expected to finish the year more than 20% higher from the end of June’s levels per the average year-end target derived from the top 15 Wall Street strategists. This forecast translates into the market recapturing most of the year’s losses, albeit finishing the year with a negative return of ~3%.
During bear markets or an extended period of a market-wide bear backdrop, investors have the unique opportunity to purchase heavily discounted stocks at a fraction of the price when compared to their peaks.
As history indicates, establishing long-term positions during corrections can lead to outsized gains over the intermediate and long term. As the selling pressure abates and the macroeconomic backdrop resolves, building equity stakes in high-quality companies bodes well for long term investors.
As the macro issues resolve over time, the markets will regain their footing and appreciate higher. The current market backdrop is the exact scenario where investors should be deploying cash on-hand to snap up heavily discounted merchandise in a diversified and dollar cost averaging manner.
Behind the Inflation Curve
The Federal Reserve has fallen far behind the inflation curve, putting through reactive interest rate hikes of 1.5 percentage points, with more to come throughout 2022.
Many politicians and executives have been sounding the inflation alarm since Q4 of 2021 to no avail while the Fed continued to buy bonds and pump liquidity into the system.
The latest inflation numbers by the Labor Department came in at 8.6%, the highest since December 1981. The reactionary Fed and runaway inflation have caused havoc on Wall Street while the Fed attempts to slam the breaks on the economy.
Second Half Bounce?
Although the first half of this year ranks among the worst in history, the selling may ease in the second half if history is any guide.
When the S&P 500 plunged 21% in the first half of 1970, it promptly reversed those losses to gain 26.5% in the second half and post a slight gain for the year. 1932, 1940, 1962 and 1970 saw first half decimation on par with 2022 however every one of those years saw a second half rebound.
Only one year saw the market recover the losses it incurred during the first half, in 1970 (Figure 1).
Figure 1 – Historical perspective of worst first half market performances and the respective full year outcomes when factoring in the second half of the year
Recession Possibility and Type
With the possibility of recession, there’s different underpinnings of a bear market that are broken out into cyclical-driven, structural-driven and “event-driven” stock declines of 20% or more.
Goldman Sachs (GS) holds the position that investors are experiencing a cyclical bear market which is marked by high inflation and rising interest rates. This combination results in price-to-earnings multiple contraction and thus a reduction in valuations.
The current climate is buffered against a structural bear market that is buoyed by strong corporate and household balance sheets. The positive side is that the average cyclical bear market lasts two years, far shorter than the average three in half years for a structural bear market. The average price decline during a cyclical bear market is only about 31% versus 57% during a structural one per Goldman.
Deploying cash into an environment where the selling is relentless and indiscriminate can be a daunting task. However, for any portfolio structure, having cash on-hand is essential and in these environments is where this cash should be deployed in equities.
This cash position provides investors with flexibility and agility when faced with market corrections. Cash enables investors to be opportunistic and capitalize on stocks that have sold off and have become de-risked.
Initiating new positions and dollar cost averaging during these extended periods of weakness are great long-term drivers of portfolio appreciation. Absent of any systemic risk, there’s a lot of fantastic entry points for many high-quality large cap companies. Investors should not remiss and capitalize on this buying opportunity because it may not last too long.
Anchoring and Dollar Cost Averaging
Purchasing stocks at the exact bottom is nearly impossible however purchasing stocks at attractive valuations in a disciplined manner over time is possible.
Dollar cost averaging is a great strategy to use when anchoring down into a position with an initial sum of capital and following through with additional incremental purchases as the stock declines further. The net benefit is reducing the average purchase price per share in a sequential fashion (i.e., reducing cost basis). An example of building out a high-quality portfolio with subsequent dollar cost averaging throughput this market weakness can be seen in Figure 2.
Figure 2 – Initiating positions in high quality companies with subsequent dollar cost averaging to build out a well-diversified portfolio. These long equity trades along with options-based trades can be found via the Trade Notification service.
This has been the stock market’s worst first-half in over 50 years where no sector has been immune from the breath and reach of this bear market. The S&P 500, Nasdaq and Russell 2000 are well in bear market territory at June’s end.
Despite this massive wealth destruction, strategists from major Wall Street firms are forecasting that stocks will recapture most of their losses in the back half of the year. The S&P 500 is expected to finish the year more than 20% higher from the end of June’s levels per top Wall Street strategists.
Purchasing stocks at the exact bottom is nearly impossible however purchasing stocks at attractive valuations in a disciplined manner over time is possible. During bear markets, investors have the unique opportunity to purchase heavily discounted stocks at a fraction of the price when compared to their peaks.
As history indicates, establishing long-term positions during corrections can lead to outsized gains over the intermediate and long term. As the selling pressure abates and the macroeconomic backdrop resolves, building equity stakes in high-quality companies bodes well for investors. The current market backdrop is the exact scenario where investors should be deploying cash on-hand to snap up heavily discounted merchandise.
Disclosure: Stock Options Dad LLC is a Registered Investment Adviser (RIA) firm specializing in options-based services and education. There are no business relationships with any companies mentioned in this article. This article reflects the opinions of the RIA. Any recommendation contained in this article is subject to change at any time. No recommendation is intended to constitute an entire portfolio. The author encourages all investors to conduct their own research and due diligence prior to investing or taking any actions in options trading. Please feel free to comment and provide feedback; the author values all responses. The author is the founder and Managing Member of Stock Options Dad LLC – A Registered Investment Adviser (RIA) firm www.stockoptionsdad.com defining risk, leveraging a minimal amount of capital and maximizing return on investment. For more engaging, short-duration options-based content, visit Stock Options Dad LLC’s YouTube channel. Please direct all inquires to [email protected]. The author holds shares of AAPL, ACN, ADBE, AMD, AMZN, ARKK, AXP, BA, BBY, C, CMG, COST, CRM, DIA, DIS, EW, FB, FDX, FXI, GOOGL, GS, HD, HON, IBB, INTC, IWM, JPM, LULU, MA, MS, MSFT, NKE, NVDA, PYPL, QCOM, QQQ, SBUX, SPY, SQ, TMO, UNH and V.
Chairman Powell’s testimony before Congress this week painted a dire economic outlook which will include the continued contraction of the national GDP coupled with continued interest rate hikes.
During his testimony, it was evident that there was a subtle difference in his word track that was uncharacteristic and a dramatic change from his usual refined method.
The chairman made it clear that the Federal Reserve has one goal in mind above all others and that is to reduce the level of inflation. They emphatically stated that the actions of the Federal Reserve will most likely lead to a recession rather than a soft landing.
Yahoo finance captured his overall demeanor in a most articulate manner saying, “He said a recession caused by the Fed’s own monetary tightening remains a “possibility.”
A soft landing, with higher rates but a still-healthy economy, would be “very challenging” to achieve. And Powell said the Fed’s fight against inflation was “unconditional,” meaning nothing will stand in its way.”
The revisions by the Federal Reserve to their monetary policy most certainly would contract the economy and bring on a recession.
A recession is defined as “a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters.”
The last GDP report revealed that the United States had an economic expansion leading to a 6.9% growth in the GDP for Q4 of 2021. If advanced estimates for the GDP Q1 are correct it will indicate a decrease in the real gross domestic product (GDP) for the first quarter of this year.
The last occurrence of a contracting GDP quarter to quarter occurred during Q2 of 2020. However, the following quarter (Q3 2020) revealed a robust increase in national GDP.
This is why next week’s report is so critical. On Wednesday, June 29 the BEA (Bureau of Economic Analysis) will release the U.S. GDP first-quarter report.
According to the advanced estimate released on April 28, “Real gross domestic product (GDP) decreased at an annual rate of 1.5 percent in the first quarter of 2022, according to the "second" estimate released by the Bureau of Economic Analysis. In the fourth quarter, real GDP increased 6.9 percent.”
Currently, there is a high probability that the actions of the Federal Reserve will lead to a recession. The question is not whether or not the United States will enter recession but rather when the recession will begin and how long the recession will last.
While a recession can stabilize gold pricing, and higher inflation certainly creates a bullish undertone for the precious yellow metal, rising interest rates have become a primary focus on the future price of gold and has pressured pricing lower since March of this year.
Gold has declined just over 12% from the highs of $2070 in March to gold’s current pricing of $1828. While it seems as though there is strong support for gold at $1800 depending on how aggressive the Federal Reserve becomes in regard to further rate hikes.
Besides the GDP report due out on Wednesday, on Thursday the government will release its latest core inflationary numbers when the U.S. PCE price index report is published.
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Relax, folks. There isn't going to be a long recession, if there is one at all, and you're probably not going to lose your job, and inflation will be down below 3% by next year. The Fed’s got your back.
That's the story from the Federal Reserve’s incredibly optimistic projections released after the end of Wednesday's interest rate-setting meeting. I use the word “incredibly” deliberately, because these projections seem anything but credible. But we can hope.
Somewhat lost in the release of the Fed's 75 basis-point hike in the federal funds rate last Wednesday is that U.S. GDP growth will remain fairly positive this year, next year, and into 2024, according to the Fed’s latest projections.
The Fed now forecasts U.S. GDP will grow by 1.7% this year as well as in 2023, rising to 1.9% in 2024. Now those are down from the Fed’s March projections, to be sure, but they still remain above recessionary (i.e., negative) levels.
Likewise, the Fed is projecting that the unemployment rate will end this year at 3.7% and 3.9% next year, before rising to 4.1% in 2024. Again, those are worse than the March projections but not overly so, considering all the scare talk about how the Fed’s newly hawkish rate-rising policy will inevitably cause a recession and a jump in unemployment.
Meanwhile the Fed is also projecting that the PCE inflation rate will end 2022 at 5.2% before dropping in half to 2.6% next year and to 2.3% in 2024, again higher than its March projections but dramatically lower than where we are today at more than 8%.
How does the Fed plan to manage all this, you ask? It sees the fed funds rate reaching 3.4% by the end of this year and 3.8% in 2022, again above its March projections but a lot lower than what you would have expected, given that the yield on the two-year Treasury note is already well above 3%.
In other words, the Fed is merely playing catch-up to where the market has already been for a while.
All in all, I would say, a pretty positive story, a lot better than what we had been expecting. But how much of it can be believed? What the Fed is telling us is that it believes it can really engineer a soft landing, meaning only a moderate rise in the unemployment rate and no recession, at the cost of just slightly higher interest rates, at least compared to today’s inflation rate and current bond market rates.
In other words, the Fed says it can tame inflation back down to less than 3% all while leaving interest rates five percentage points below the current 8% inflation rate. Is that possible?
Meanwhile, what is President Biden doing for his part in trying to drive down inflation? Other than not interfering with Fed policy, which he claims is basically all he can do, he is blaming oil executives for the high price of gasoline.
Short of charging them with getting in bed with Vladimir Putin, he's laying the blame for high energy prices on their failure to explore and drill for oil, leaving out his administration's role in basically forbidding them to do just that and putting pressure, through the Fed and other means, not to lend them money in order for them to do so.
You would think Biden would have been happy that they are not drilling for oil, contributing as they are to the blissful carbon-free future he imagines. But he seems to believe he can have it both ways, namely no new oil production and low gas prices. But I guess that’s the same type of logic the Fed is using in trying to convince us it can whip inflation with a few interest rate hikes with little harm to the overall economy.
The market reaction to all this was fairly predictable. Right after the Fed rate announcement was greeted with euphoria on Wednesday, people woke up the next morning and said, “Hey, wait a minute. This can't possibly be true,” and the selling resumed with renewed fervor.
And why not? Can we take any comfort in what the Fed and our government are telling us, which is that after a dozen years of easy money, quantitative easing, artificially low interest rates, and massive fiscal and monetary stimulus, they can undo all that in a year or so without anyone being inconvenienced?
If only it worked that easily. If Powell wanted to be honest, he could have said, “Folks, there will be a lot of pain over the next couple of years to undo all we have done over the past decade, so brace yourselves for it.”
But people don’t want to hear that, especially in an election year. Although the market seems to know better.
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.