|[source: Star Tribune]|
The market has been quick to respond, and nothing was hit harder by a reduction in inflation expectations than commodities. Gold, since the announcement, is lower by 2.39%, and oil is down -3.18%. Crude futures have broken their upward trend line and appear poised to test the previous low of $39.56.
While, oil has been under pressure all year, the S&P 500 does not seem to care, as it continues to make all-time highs. Oil is down 23% year to date, while the S&P is up close to 9%. In 2016 the opposite was the case. Then, the market paid very close attention to what oil was doing, especially as it drifted close to 40 dollars a barrel and below. Below $40 a barrel, the market became increasingly worried that there could be a contagion effect. We had a situation where domestic oil producers’ balance sheets were questioned by the market, followed by a spillover effect to regional banks who owned that debt. That is the type of financial crisis credit owners fear. This culminated on February 11, 2016, when oil bottomed out at $26.21. This dangerously low oil price for shale producers sent the VIX to 28.14, and the S&P to 1829.08.
The market has been eased with oil over $40 dollars a barrel, a level which shale producers can safely turn a profit, thus eliminating the contagion risk. Right now, it seems the oil trend-line is breaking, headed lower, while the stock market is still hovering very close to all-time highs.
Oil is still above the key $40 dollars a barrel technical level, or $39.51 to be exact, and at this point, investors seem confident oil will remain above that level. Oil could be one supply glut short of being sent back to the 2016 low. Meanwhile, volatility remains historically low, Today's June settlement was 10.71. Volatility traders should watch the $39.51 in oil level closely, while being mindful of what happened in February 2016, and the effect it can have on our stock market risk.
- Joe Tigay