A shortened holiday week but warning signs are beginning to flash as the continued slide in oil prices signals that a slowdown in the global economy may be on the way. Below is a chart over the last two years shows that oil is giving back all its gains in a matter of weeks. Oil lower prices will impact much of the high yield bond market as many players in shale oil will be impacted if oil gets much below $50.
Early October also marked a top in the S&P 500 and the other major indices which are currently struggling to make a turnaround. Below is the S&P 500 ETF:
So, what happened? Central banks are hitting the brakes on their bond buying programs. The reductions will accelerate into 2019 as the U.S., Europe and Japan will hold hands and hope for the best in 2019. These reductions are supposed to be “gradual” but when the sheer magnitude of these programs are in the Trillions even a small reduction is $100 billion monthly. And that was what happened in October – a reduction of $100B in bond purchases. This program is just starting as central banks attempt to reduce their balance sheets and backtrack to the pre-crisis levels which will take years.
Why do stocks care? The bond purchases provide liquidity to financial markets which in turn gives the private sector the ability to borrow fund long-term capital investment (building factories). However, much of this borrowed money ended up going into stock buyback programs which have helped fuel equity markets higher and higher over the last several years. This perpetual motion machine for stocks is cycling down as interest rates rise and central banks withdraw liquidity from the system. Will the Fed blink in December if the stock market forces their hand over the next few weeks? Stay tuned.
What to look for next week:
- Stocks will test the 10/29 low which must hold if the market is to find a bottom.
- Oil. Looks like sub-$50 is coming up. We moved from $57 to $51 last week so lower prices are in play.
- Credit. Corporate credit spreads are widening which increases the rate of borrowing for corporate America.
Good luck out there, it is going to be interesting Q4. That is all for now until next week’s Market Update. If someone forwarded you a copy of this report, you can sign-up directly at www.kiscocap.com.
Please reach out to me if there is anything you want to discuss about the markets, your portfolio (for clients) or if you would like a copy of the firm’s brochure if you are not a client.
Paul J. McCarthy, III
President – Kisco Capital