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How selloffs in tech and energy stocks could 'reset' US markets

Peter Kenny
Peter Kenny

By Peter Kenny, chief market strategist for Global Markets Advisory Group and independent market strategist at Kenny & Co. LLC

If crude oil is a metaphorical canary in the coal mine in regards to economic vitality, equity investors certainly aren’t paying much attention. On May 24, WTI crude (CLQ17.NYM) closed at $51.36/bbl. This past Friday, it closed at $43.17/bbl after rallying from an intra-day low of $42.62/bbl. That performance (-16%) for WTI crude should be a data point worthy of consideration for investors, particularly considering that both OPEC and non-OPEC members are making concerted efforts to prop up crude prices. The 16% drop in WTI in the wake of the bi-annual OPEC meeting is significant in and of itself. But what, if anything, does it tell us of the broader economic climate?

Source: Getty Images

I have long written about the strategic significance of crude as a barometer of global economic vitality, but increasingly it appears as though it is either losing its predictive relevance or investors are ignoring it at their own peril.

Investors are ignoring the crude oil meltdown

Consider that during the same 30-day period that crude dropped by -16%, the S&P 500 (^GSPC, SPY) has moved from a low of 2,398 to 2,434.75 for a modest gain of 1.5%. Any gain in equities, given the backdrop provided by crude and the resultant drag of the energy sector on the broader market, is noteworthy. Can US equites continue to defy the meltdown in energy prices? And if so, for how long?

Tech ( XLK) and health care ( XLV) are the leading S&P 500 sectors, while telecom ( IYZ) and energy ( XLE) are the worst performers. (Source: Standard & Poor’s)

Given that the down draft in crude prices is being fueled by several themes, including increased efficiency by US shale producers, leaky OPEC production limits and a resultant global supply glut, there may be a case to be made that unlike in years past, the consumption/demand side of the equation is not the direct driver of price that it once was. I remember telling a colleague after crude’s historic route in recent years that we wouldn’t see a “7” handle ($70/bbl or more) on crude again in our lifetimes. As time has passed, that call seems increasingly optimistic. Given the global market forces at work, we may not even get close to a “7” handle again.

This time it’s different?

If crude remains under pressure, does that necessarily mean that an economic slowdown is on the horizon? Historically speaking, there has been a correlation, but we may be entering a new energy/equity markets paradigm.

As the year-to-date chart of S&P 500 sectors above illustrates, the energy sector (XLE) has been far and away the worst performing sector of all twelve. Leading the charge in positive performance, not surprisingly, and as we have discussed in recent notes, has been information technology (XLK). The poster boys for that sector (FANG stocks: FB, AMZN, NFLX, GOOGL) have provided more than enough lift to keep the overall equity market index performances constructive. If, as I have suggested in recent notes will happen, the technology sector loses momentum and relinquishes leadership, the broader market will suffer.

In interviews over the past five weeks, I have made the case for lower energy prices and a rotation out of large cap tech/information technology. We have clearly seen the trade lower in energy materialize and we have seen some recent weakness in tech as well. If large cap tech experiences continued challenges in regards to its upward momentum, look for a reset in US equity prices that may well shave as much as 5% off index levels. That reset will ultimately be constructive for the longer term trade higher in equities.