Failed Oil Rally Leads to a Nasty Reversal Day

The trading day started with so much promise!!  

Talk of an imminent merger between Dow Chemical and DuPont had M&A circles buzzing of this cycle’s Mega Deal, and sparked life into Basic Material stocks around the globe.

The NASDAQ, which had been within 1% of a new closing all time high 1 week ago, was being rewarded for its out-performance this quarter with a bullish “Golden Cross” as the 50 day MA had moved through the 200 day MA for the first time since September 25th.

The slope of the 200 day MA has flattened considerably the last 3 months, but has never turned to trend lower.  With the year’s biggest gainers leading the NASDAQ, fresh closing highs before year end looked promising.

Failed Oil Rally Leads to a Nasty Reversal Day

Oil was sporting moderate gains of +1% to start the day.  Oil stocks were bid higher after a harsh beating the last 2 weeks.  At 10:30 the Oil Inventory report showed a draw down of 3.6 million barrels, breaking an 11 week string of oil inventory builds.  Within 10 minutes Oil had doubled its gains,

Oil stocks were predominately green for the first time this month, and the S&P 500 was trading through Tuesday’s highs with a 20+ handle gain.

It didn’t last very long

While the draw down in the Oil inventory report was unexpected The same report showed no drop at all in production, consistent with the outcome of the OPEC meeting from last week.  Reality quickly set in that even with oil trading in the high $30s production will continue to run near capacity and a 1 week draw of 3½ million barrels is the proverbial “pimple on the ass” of the elephant in the room….Supply.

There’s just no way around it.  The World is awash in Oil.  Supply everywhere.

It didn’t take long for institutional selling to hit just every sector of the market.  By 12:00 noon the early gains were gone and the S&P 500 was flat on the day. An hour later we were down 20 handles, a stunning 40+ point reversal in the S&P 500 in less than 2½ hours.   The good news is the lows from 12:45 PM to 1:30 PM held for the remainder of the day.

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The final tally; DJIA -0.4% to 17.492; S&P 500 -0.8% to 2047.62; and NASDAQ -1.5% to 5022.87  certainly doesn’t look like a route, until you consider that we had 1%+ gains less than 90 minutes into the day.

On the surface it’s curious that The NASDAQ had 2x the decline of the S&P 500, but this is easily explained away through the dynamics of year end portfolio management.  Clearly there’s been relentless tax loss selling and portfolio liquidation in oil and energy names that will likely carry on for at least another week.  These realized losses have no value in the current year unless they can be matched up with realized gains.

Look at the price action yesterday in some of the best performing stocks this year:  FB, GOOG, AMZN, NFLX, IBB (and any of its components).  It’s clear that Big Dough institutions that are having a wholesale liquidation in secondary and tertiary oil names are matching those losses up with gains from their biggest winners.

Where do we go from here?   

Not to be deterred by the brutal reversal yesterday, weak overnight markets in Asia where the Chinese Shanghai Composite closed at its lowest level in 8 weeks, and Crude Oil that is now in a world where the $38 – $40 level is resistance the last 3 days, Investors are determined to give it another go today.

Stock futures are pointing toward a moderately higher opening a couple hours from now.   Oil, on the other hand, is fractionally lower with the $36 level looking like soft support in the near term.   If Oil breaks lower and trades below $35 it will be a great test for the resilience of the bulls.

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