Markets came alive last week and most of the activity can be attributed to oil prices, which continued to spiral sharply downward.
Seemingly out of nowhere, the energy sector has emerged as the must-watch spot of the global financial system. Oil prices have been sleepy for years, creating the impression of stability.
But as Harry and I have said before: “Stability breeds instability.”
And now that prices have cracked lower, unleashing a torrent of volatility in related markets (nearly everything is affected by oil prices to some degree), investors are beginning to worry about the unknown implications of a possible “new normal” in the global energy complex.
And while the price of oil will have measureable (and forecastable) effects — both good and bad — on various asset classes around the world, these calculations are largely meaningless today.
Instead of making careful calculations, investors are simply leaning toward a defensive stance, in a logical acknowledgement of the future’s unknowns.
Basically, oil is now a huge question mark in the equation that describes the global economy. And until we have a clearer picture of that variable, expect investors to err on the side of caution.
Now, let’s take a closer look at these trends as we go around the market in 10 seconds…
• Global stock markets fell across the board. Interestingly, though, small-cap stocks (IWM) fell only mildly. The Russell 2000 lost 2.5%, while the Dow dropped 3.6%. Typically, in a clearly risk-off environment, as last week was, you’d expect to see the opposite. While it’s too soon to tell, this may be an early signal that small-cap stocks are on the verge of recovering from their year-long slump. I’m keeping a close eye on this development and will let you know if/when small-cap stocks make a bullish break higher.
• Bond markets mostly rose, but performance was split along the “quality” divider. Meaning, high-quality issues — like Treasury bonds (IEF) — traded higher, while riskier quality bonds — like emerging-market (EMB) and junk (JNK) bonds — dropped sharply. The spread between IEF and JNK grew a strong 5.65% last week, revealing investors preference for safety.
• Commodity markets were led lower by a 12% drop in oil (USO), although gold and silver prices traded higher. In general, the commodities complex is still looking bearish under the weight of global deflationary trends. We don’t expect this to change anytime soon.