Momentum is Back, Breadth Rallies; It’s Truth Time for OPEC and Crude Oil

The week of June 5 should be momentous, as the bears who have been left behind consider whether to fully capitulate.

The stock market is back in rally mode as seasonal tendencies for a summer rally, especially in the third year of the presidential cycle, assert their influence. Especially comforting is the recovery in the market's breadth, as measured by the NYSE Advance Decline line (see below). The U.S. economy is showing signs of slowing, as the rate of rise in inflation is flattening.

Of course, things could change instantly, especially if, as I discuss below, OPEC does something very dramatic at its June 3-4 meeting. Moreover, it's all about whether the Fed leaves rates unchanged in June in order to see if the current flattening out of inflationary pressures is a prelude to an actual decline, and what that does to bond yields.  

I'll have more on bonds below. First, a few words about the oil market.

OPEC's Credibility is on the Line

Last week, I suggested that shorting a dull market is not a good idea. I was referring to the nearly complete lack of bulls in the oil market and suggested the energy sector was ripe for a bounce.

As I went to press on this post, rumors were circulating that OPEC was considering a 1 million barrel per day production cut, to be announced at the conclusion of its June 3-4 meeting. This cut, if it happens, will be in addition to production cuts previously announced, which are starting to make their way through the system and could possibly reduce global oil supply meaningfully.

Oil (WTIC) rallied on 6/2/23 on the OPEC rumors and signs that oil production is already being reduced. For example, the U.S. Rig count fell for the fifth consecutive week. Meanwhile, Canada's oil sands giant Suncor announced 1500 job cuts. There are also rumors floating around that job cuts are coming in the fracking sector in the U.S., as the number of active crews finishing wells is also shrinking. 

Here is the bottom line:

The U.S. oil industry is dialing back production, and OPEC seems to be on a similar course. If OPEC flakes out, they risk losing their ability to influence the price of oil, at least for the foreseeable future.

Watch the market's response to OPEC's announcement. If WTIC's price rises above $75 decisively, then current market relationships, especially bond yields, stock prices, and what the Fed does at its upcoming FOMC meeting (June 13-14), will likely be affected.

I've recently recommended several energy sector picks. You can have a look at them with a free trial to my service. In addition, I've posted a Special Report on the oil market, which you can gain access to here.

Bond Yields Test Resistance

The latest monthly payroll numbers were well above expectations, but the bond market is focusing on other signs that the economy is slowing. As I noted last week, bond yields are likely to fall once the economy shows signs of slowing and the Fed admits that it must at least stop raising rates. Here are some signs that perhaps we're not too far from that point:

Dallas Fed Survey crashes, falling for 13th consecutive month; one respondent noted: "There is nothing encouraging on the horizon." Other notable quotes: "orders canceled," and "order volume has stalled recently," and "seeing a massive slowdown." Dallas Fed services survey fell for 12th straight month. Comments worth noting: "Businesses are preparing for a recession by looking for ways to cut back, which in some ways, works to create a self-fulfilling prophecy." Chicago PMI Collapses – new orders, prices paid, production, inventories and employment fell. China manufacturing PMI fell below 50, signaling contraction. U.S. PMI and ISM surveys fell again. China's economy is showing signs of slowing.

Beige Book Confirms Slowing U.S. Growth

Confirming the negative news above, the Fed's most recent Beige Book offered the following:

Prices are rising but are doing so more slowly. New York and Philadelphia registered slowing economic activity. Boston, Cleveland, Richmond, Chicago, St. Louis, and Kansas City reported flat activity. San Francisco, Dallas, and Minneapolis reported slight growth.

The bottom line is that inflation seems to be rising at a slower pace and that the U.S. economy is slowing, as eight of eleven Fed districts reported slowing or flat economic activity. The three that reported growth described it as slight to moderate.

Bond Yields Test Resistance. Mortgages Follow. Homebuilders Perk Up.

The most predictable relationship in the stock market currently is the one which connects bond yields, mortgage rates, and homebuilder stocks. When bond yields fall, mortgage rates follow. Increases in home sales register and homebuilder stocks rally.

The crucial yield point on the U.S. Ten Year Note is 3.85%. If yields remain below this level, the environment should remain stable.

Moreover, if I'm right and the economy continues to slow, bond yields will roll over, and mortgage rates will drop as demand for new homes will once again pick up.

As things stood last week, SPHB seems to have made a short term bottom as traders begin to factor in the scenario above. 

If the U.S. Ten Year Note yield (TNX) remains below 3.7%, it's a sign that bond traders are less worried about inflation. This should be bullish for homebuilder stocks.

For an in-depth comprehensive outlook on the homebuilder sector, click here.

NYAD Rallies. SPX Joins NDX's Breakout. Liquidity is Stable. VIX Hits New Low.

It was quite the week for the market's technical picture.

The New York Stock Exchange Advance Decline line (NYAD) rallied back above its 50-day moving average, signaling stocks are back in an uptrend.

The Nasdaq 100 Index (NDX) extended its recent breakout, closing the week well above 14,500. The current move is unsustainable, so some sort of pullback and consolidation are likely over the next few days to weeks. On the other hand, it could take some time for a consolidation or pull back to develop, as both ADI and OBV are in solid uptrends, signaling lots of upward momentum.

The S&P 500 (SPX) finally broke out above the 4100-4200 trading range, decisively confirming the trend in NDX. On Balance Volume (OBV) continues to improve, while the Accumulation Distribution (ADI) indicator remained in an upward trend.

VIX Breaks to New Lows

The CBOE Volatility Index (VIX) broke to a new low as call option buyers overwhelmed the market. This is probably a little too much bullishness all at once, so we'll see how long it lasts.

When the VIX rises, stocks tend to fall, as rising put volume is a sign that market makers are selling stock index futures to hedge their put sales to the public. A fall in VIX is bullish, as it means less put option buying, and it eventually leads to call buying, which causes market makers to hedge by buying stock index futures. This raises the odds of higher stock prices.

Liquidity is Still Limited

The market's liquidity may have bottomed out, but it's not particularly bullish. The Eurodollar Index (XED) failed to rally above 94.5, which is a bearish development. For now, it's good enough to keep the rally from imploding. A move below 94 would be very bearish.

A move above 95 will be a bullish development. Usually, a stable or rising XED is very bullish for stocks.

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Joe Duarte

In The Money Options

Joe Duarte is a former money manager, an active trader, and a widely recognized independent stock market analyst since 1987. He is author of eight investment books, including the best-selling Trading Options for Dummies, rated a TOP Options Book for 2018 by Benzinga.com and now in its third edition, plus The Everything Investing in Your 20s and 30s Book and six other trading books.

The Everything Investing in Your 20s and 30s Book is available at Amazon and Barnes and Noble. It has also been recommended as a Washington Post Color of Money Book of the Month.

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