In the past week, U.S. crude futures plummeted 8 percent, and that weighed on equities with the energy sector sliding 6 percent. The broader market also got pounded, with the S&P down 3.6 percent to 2,023, its worst weekly performance since Aug. 21.
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Energy analyst John Kilduff of Again Capital said oil could react to the French attacks, particularly if they are linked to ISIS or al-Qaeda. West Texas Intermediate crude oil futures settled Friday afternoon at $ 40.74 per barrel, and analysts expect a retest of the $ 37.75 low set in late August.
“Hostilities have been on the rise, and if this is linked or the (Russian) plane downing is linked to the Syria situation, it’s going to intensify efforts in the region, and we could see some significant oil assets coming into the crosshairs,” said Kilduff.
Strategists have been expecting a brief pullback for stocks, and some expect any downturn to be followed by a Santa rally into the new year. Traders point to some of the technical damage done in the past week, with Apple down more than 7 percent after the stock gapped lower early in the week. The S&P broke through both its 200-day and 100-day moving averages Thursday and Friday.
“A lot of people were expecting the market to finally give up some of the gains it made in its rally, given the widening of credit spreads…. Oil and just about every commodity you can think of has broken down again, if not to new lows to pretty close to lows. That has a relation to what’s going on in high yield because a lot of those companies are commodity producers or suppliers to commodities producers,” said David Bianco, chief U.S. equity strategist at Deutsche Bank.
Retail will also continue to be a focus in the coming week with earnings from Wal-Mart, Target, Home Depot and Best Buy. Disappointing earnings and forecasts dented stocks in the past week of Macy’s, Nordstrom and others.
“It’s been a disappointing earnings season, especially with the retailers sounding a sour note at the end of the quarter,” said Bianco. “The uplift on nonauto consumer spending on consumer goods has been weak. I think we’re looking at the most competition among retailers outside a recession that we’ve ever seen. A lot of it is for structural reasons, whether they’re competing with the Internet, and you now have several large retailers that have everyday low prices now.”
Weak earnings, high valuations, declining commodities prices, slower Chinese growth and now worry about the consumer, rose to the surface as traders continue to adjust to the idea that the Fed could be about to raise rates at its Dec. 16 meeting.
“There’s a lot of room for the market to move up and down over the next few weeks,” said Daniel Suzuki, Band of America Merrill Lynch equity strategist. “Our base case was to take a more cautious view. We know the uncertainty overhang is still going to be there, and the reality that you’re unlikely to get hard macrodata point to improving growth until December, when we get November data. We know September was weak, and we got the data that confirmed that. October looks to be flattish.”
The S&P 500 had recovered about 10 percent from its summer sell-off, and the forward price to earnings ratio was once again above 17 at the start of the past week. “I think it’s a little bit of everything,” Suzuki said of the sell-off. “If you think back to where we were in August, the markets were essentially pricing in a collapse in global growth, and when you didn’t get the collapse the market has to price it out. And I think that was the biggest driver of the recovery in the markets, but we’ve been surprised at how strong and fast the recovery has been given the lack of hard data…. Most of this rally has been a result of sentiment and central bank rhetoric as opposed to any meaningful change in the fundamental data.”
Suzuki said the drop in oil hurt sentiment, and some strategists say stocks are more sensitive to oil prices when they fall below $ 45 per barrel. “I think people had gotten a bit more optimistic for the outlook for oil,” he said, adding the outlook for oil companies also improved with oil in the upper $ 40s. “Because they’ve been able to dramatically reduce their costs, there was increased confidence that some companies were going to be able to survive. And some were going to be able to be profitable with oil prices where they were. But now as we get to $ 40 and people think it could fall into the $ 30s, that thesis gets less viable.”
Zane Brown, fixed-income strategist at Lord Abbett, said the bond market will be watching anything to do with Fed policy in the coming week, so minutes of the last meeting will be important on Wednesday, as will the Consumer Price Index inflation data.
Brown said investors have become concerned about the widening of high-yield spreads. As of Friday afternoon, the J.P. Morgan High-Yield Index was 15 basis points wider on the day at 678, up from 635 the week earlier, said Brown. The long-term relationship is usually about 590, he said.
“There really does seem to be an underlying concern that we are close to the end of the credit cycle … a lot of that is misplaced, and it’s misplaced because they’re looking at the impact of oil and what it’s doing to companies,” he said. “There are increased defaults there. I think that is being applied to the entire credit spectrum, particularly the below-investment-grade spectrum.”
But Brown said the credit situation is not really similar to the end of other cycles. “The leverage isn’t the same, the earnings relative to interest-rate levels is better,” he said, adding investors are also more selective. Another difference is that the quality of issues coming to market is better.
In terms of new, high-yield corporate issuance so far this year, Brown said 55 percent were rated BB and higher, while 45 percent was at the lower end of the credit scale, at B or lower. That is far different than other cycles when the lower-quality issues made up as much as 75 percent of the new issuance, he said.