Analysis, Perspective, Trading Strategy

Santa Claus Rally Needs Fueling from Reversal in Crashing Crude and Help from the Fed

By Joe Duarte on November 18, 2018

Traditionally, the arrival of Thanksgiving marks the proximity of the Santa Claus rally on Wall Street. And while this year may turn out to not be different than most years, a lot depends on the Federal Reserve, the bond market, and the price of crude oil.

You know this time is different when the Federal Reserve’s chairman Jerome Powell admitted the global economy may be slowing and the Vice Chairman suggested the central bank may consider a neutral bias toward interest rates within one day of one another last week. The big winner of the Fed’s latest pronouncements, unfortunately for stock traders, has been the U.S. Ten Year Note yield (TNX) – see below for full details- which I noted last week was close to a decision point given the potential for a slowing economy.

And while it would be welcome news if the Fed took a break from their quest toward higher interest rates, there is still a great deal to sort out in this market where significant technical damage has occurred. Furthermore, the big question is whether the Santa Claus rally is even within the cards at the moment given the landscape.

This is a valid and significant question to consider as there are four troubling fundamental issues at the moment whose next moves could well hold the answer to the Santa Rally question and perhaps what happens in the stock market in 2019:

1) The number of air pockets in stocks that misfire is rising. Think Network Appliance (NSDQ: NTAP) and Nordstrom (NYSE: JWN).

2) An increasing number of companies are giving poor guidance for future quarters. Think Nvidia (NSDQ: NVDA).

3) When the bond market signals the Federal Reserve that it disagrees with the central bank, and the central bank seems to pay attention before all hell breaks loose beyond repair, you know you are leaving the Twilight Zone and entering the Outer Limits.

4) The relationship between bond yields, crude oil prices, and the stock market is signaling caution.

Market Breadth Gropes for Support

I’ve been watching the New York Stock Exchange Advance Decline line (NYAD) for liquidity clues in the stock market for many years. Moreover this indicator, as the chart below shows has been particularly accurate in predicting the general trend of the stock market since the 2016 presidential election, which is why its current posture remains concerning while providing a slight glimmer of hope for the bulls.

And while last week’s failure to rise above its 50-day moving average is concerning, NYAD managed to end the week on a positive note. Still, there is the rolling over of the ROC indicator, which measures momentum which is diverging from the RSI which like NYAD seems to be trying to recover. What’s left to see is whether the NYAD can hold above its 200-day moving average and use the average as support point from which to launch a credible intermediate term rally. If the NYAD breaks below its 200 – day moving average decisively and it extend the decline below the key line I would expect yet another painful down leg in stocks.

Indexes Struggle for Trading Bottom

As the market’s breadth struggles so are the major indexes looking to find their footing. So far the Nasdaq 100 (NDX) has not broken to a new low with 6600 remaining the floor. Meanwhile the S & P 500 (SPX) has not fallen below 2600, near its most recent low.

Comparing the two indexes we can see that SPX is looking less damaged than NDX, which makes sense given the bounce in consumer staple stocks such as Coca Cola (KO) and steady dividend plays such as Hormel (HRL).

Moreover, the relationship between rising interest rates and falling stocks has never been clearer. The chart of the U.S. Ten Year bond yield (TNX) shows that market interest rates have risen significantly in the past 12 months. And while stocks managed to continue their rise for most of that period, once yields crossed above 3.10% convincingly, all bets were off.

Nevertheless, this market still has a fair amount of work to do as the drag on NDX from the FAANG stocks (FNGU) is still sizeable and could linger for a while.

Perhaps the most important chart pair of the moment is that of the U.S. Ten Year note (TNX) and the price of West Texas Intermediate Crude (WTIC). TNX shows a fairly abrupt drop in its yield seemingly moving toward 3%, signaling that the bond market is betting on a slowing economy.

With regard to crude oil, aside from its complete price crash and burn, note the excellent correlation within the last two years of the price in SPX and WTIC. This suggests that if and when a bounce in crude oil arrives, we may see a more credible and perhaps convincing rally in stocks. With cold weather moving in we could see a seasonal bounce in crude.

For Santa Rally to materialize Oil will have to show signs of life

Seasonally speaking we are nearing the Santa Claus rally time of the year and given the oversold state of the stock market we may get something of a bounce. Still, there are lots of headwinds at the moment as the economy seems to be slowing and the Fed is becoming a bit of an intangible, especially if it decides to pause its current trajectory toward higher interest rates a break at or after its December meeting.

Moreover, technically speaking, the price action in the bond and crude oil markets suggest traders are betting on a significant slowing in the U.S. and the global economy confirming what the rising perception seems to be.

All said, the Federal Reserve’s recent comments, the price of oil, falling bond yields and the sluggish bounce in the stock market suggests that until proven otherwise any rally in stocks will likely be fueled by a series of events which raises the price of crude oil.

However, if the Fed makes it clear that it’s taking a pause, and perhaps skips its highly expected rate increase in December and we get a bottom in crude oil, given the strong seasonality, we may actually get a surprisingly rewarding Santa Claus rally.

I own shares in HRL as of this writing.

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