On a recent edition of the Financial Sense Newshour Jim Puplava discussed market conditions with Richard Dickson of Lowry Research. Dickson explained what his technical indicators show about current market conditions. Then Robert Rapier joined the program to discuss what’s happening in the energy markets and with a potential Aramco IPO.
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Two Indicators Suggest Market Strength Ahead
Dickson's primary indicators point to a continuation of the current bull trend. He tracks buying and selling pressure to determine the overall health of the market. This requires examining demand and supply in markets. There’s an expansion of demand as measured by the Buying Power Index. Conversely, we’re seeing a contraction of supply as measured by the Selling Pressure Index.
Lowry Research uses the spread between the two indexes to measure the balance of supply and demand, and it is slightly more positive than it was at the July high. Since the Oct. 2 low, that minor low we had in the market has been well supported by rising demand and falling supply, which is an excellent indicator of further strength, Dickson said.
We saw a period coming off the December low with a rapid rise in demand and similar rapid fall in supply. This setup normally happens when we are coming off a significant market low. We started to see a drop off in demand and a rise in supply in April that preceded the S&P 500 high. Conditions then bottomed at the Jan. 4 low. Since then, Dickson believes things are headed in the right direction.
“The trends are what we hope to see,” Dickson said. “We want a rising trend, and we want to see buying in a dropping trend in supply. As far as these two measures are concerned, the market appears to be firing on all cylinders right now.”
Dickson looks at the advance-decline lines for the S&P 500 400 mid caps and 600 small caps. He also tracks the percentage of stocks that are down 20% or more for their highs on a segment basis. These also indicate a positive trend, he said. Though the number of new highs may be lagging slightly, it's mostly in the large caps, as measured by the percentage of stocks at or within two percent of their highs.
Conversely, the small caps are higher than they were in July. Dickson said this is the opposite of what he’d expect to see if we were in an aging bull market. Instead, both small caps and mid caps are outperforming large caps. This is yet another positive sign that market conditions are going to continue showing strength.
“We're seeing somewhat of a rejuvenation in the market,” Dickson said. “Obviously, we’ve seen strength in things like basic materials, financials and industrials, where some of those had been lagging in the second and third quarter of this year. Now, they're starting to take a leading role. That has helped the laggard small caps to really outperform the large gaps. That's another good sign for the market.”
What Does a Market Top Look Like?
Historically, market tops share similar characteristics though they are not identical. Deteriorating breadth begins with small cap stocks, which are currently showing strength. The signal for deterioration of breadth is seen in a divergence where the market is making new highs while the advance-decline lines are not. Rather, it appears advance-decline lines have been leading the price indexes higher.
A trend in rising supply is another indicator of change. Investors see overvalued stocks and begin profit-taking. This isn’t what we’re seeing in the markets now, in fact, buying power has been heading up steadily and selling pressure has been heading lower.
Santa Clause Rally
Dickson believes last year’s December market deterioration is unlikely to come back for a second a year. The differences in markets year to date are too numerous, he said. We haven’t seen any lag in breadth or poor performance in the buying power and selling pressure indexes. There are some signs of selectivity when it comes to buying, Dickson noted, and some price momentum indicators are at levels where we’ve had pullbacks.
These indicators suggest caution, but not outright bearish sentiment. A short-term pullback is certainly possible, Dickson said, but if one occurs, it would be within the context of the current dominant uptrend. Without any sign of deterioration in that dominant uptrend, such as we observed last September, a counter trend pullback will be minor.
“Demand may have dried up a little bit and we've had some very minor hiccups in last couple of weeks,” Dickson said. “ But overall, there has been no significant rise in selling. That again is a sign of a strong trend.” He added “I wouldn't be surprised if we see a Santa Rally. Everything seems to be disgustingly healthy right now for the market.”
Bull or Bear Market?
The U.S. has been in the same bull market since March of 2009. While many see this as a reason to worry about deterioration, Dickson pointed out that in order to enter a bear market, we first need to see signs of a major market top. As of September 2008, we have not seen those signs.
Lowry Research sees last year’s market drop as a 20% correction amidst the longest bull market in history. Rather than signs of age, Dickson’s seeing signs of renewal in the bull trend. For investors sitting on the sidelines, he advises making a few adjustments. The best course of action may be to take a look at your portfolio and identify stocks that are not performing. The idea is to refresh your portfolio in anticipation of continued strength and a possible rally into year-end. Look for lagging stocks, Dickson advised, and consider raising cash to possibly reposition at some point.
“There's really no reason at this point in time to be thinking about selling other than to restructure your portfolio,” Dickson said. “You haven't accomplished anything by waiting. … If you're waiting for a bear market, you may still have a long wait. It'd be a better idea to put some money to work.”
Aramco IPO Faltering
Later in the program, Financial Sense Newshour spoke with energy expert Robert Rapier, who gave an update on the energy markets and an Aramco IPO.
While some valuations have put the IPO at $2 trillion, the consensus among bankers is at $1.5 trillion, and even that could be optimistic. The culprit is U.S. shale production, which has substantially harmed Aramco’s IPO prospects. If not for U.S. shale knocking down oil prices, Rapier added, Aramco could have reached $2 trillion.
Instead, shale production keeps expanding, maintaining pressure on oil prices. This is happening against a backdrop waning OPEC influence, Rapier said. While the cartel certainly still has tremendous sway over markets, it isn’t anywhere near the level of control it enjoyed in 2006 and 2007.
As U.S. oil production continues to expand, OPEC continues to cut production to maintain prices, which leaves it in a no-win situation. If OPEC holds or expands production, it will crash the oil price. The only way to prop up oil prices is to cut production, which helps U.S. shale producers. OPEC tried to expand production and crash prices in 2014, attempting to harm U.S. shale producers. But this didn’t have the desired impact of putting enough shale players out of business. Instead, the U.S. shale industry showed remarkable resilience.
“OPEC is still paying for that decision today,” Rapier said. “If it had started to cut oil production back in 2014, we would probably have seen oil prices remain propped up in the $75 to $100 range instead of where they are now.”
IPO Less Attractive to U.S. Investors
There are special risks associated with the Aramco IPO, and Rapier said he’d advise novice investors not to buy Aramco stock. There are safer options with good dividends available from U.S.-based oil companies. This allows investors to avoid the obvious geopolitical and governmental risks foreign oil companies can present.
Some analysts have pointed to the perceived decline in year-over-year growing in shale production, but Rapier says this fear is overblown. In the summer of 2019, it appeared that shale production was slowing down. However, the trend has reversed, and production appears to be heading up. The production numbers from the EIA showed 12.6 million barrels a day of domestic production. This is 1.4 million barrels a day higher than a year ago, Rapier noted, representing a substantial year-over-year increase.
New shale wells are not producing at the same rate as older legacy wells because companies have moved into less optimal real estate in addition to a falling rig count. Evening these conditions is the fact that around 8,000 drilled but uncompleted wells exist right now. These wells have been drilled but have not yet been fracked.
“It's like money in the bank,” Rapier said. “Producers are sitting there, waiting. Even if the rig count fell to zero today, they'd still be able to go ahead and frack those wells. So there's quite a bit of an inventory there. Eventually as rig count falls, we will see production start to slow down and tail off. But with all that drilled but uncompleted inventory, there's going to be a bit of a lag.”
Value in the Oil Sector
Rapier sees opportunity the midstream pipeline companies and in oil producers, though it may take some time for this to play out. Oil producers—and especially the smaller producers—are still going to suffer for a while, he noted. Instead, larger producers are well positioned to continue doing well. While many of these players have been hit hard in the last few months, their cashflow is increasing and distribution coverage is increasing.
“The biggest value right now is probably in midstream,” Rapier said. “In the longer term, if you pick up some of those oil companies, some are generating enough cash flow right now at $50 oil that they're not taking on debt to survive.”
Written by Ethan D. Mizer