NEXT DOWNSIDE TARGET FOR CRUDE OIL RANGES FROM $40 TO THE MID-$30S -- GLOBAL DEFLATIONARY PRESSURES PULL 10-YEAR TREASURY YIELD BELOW 2% -- FALLING FOREIGN CURRENCIES SHOW WEAKNESS ABROAD -- EMU ISHARES HAVE WEIGHED ON U.S. STOCKS
LONGER RANGE VIEW OF CRUDE OIL ... The plunging price of oil is driving financial trends all over the world. Plunging oil is hurting energy companies that produce that commodity, as well as countries that are energy exporters. In addition, its deflationary effect is pulling global bond yields lower and contributing to the buying of government bonds in Europe, Japan, and the U.S. Plunging foreign currencies are pushing the U.S. dollar to the highest level in a decade, which is making the plunge in commodity prices even worse. All of that being the case, it's worth a longer-range look at that key commodity to determine how much further it can fall, and where it might find some long-term support. The monthly bars in Chart 1 show the trend of Light Crude Oil since the early 1980s (when it first started trading). Between 1980 and 2004, the $40 level acted as a ceiling on the price of crude. An upside breakout in 2004, however, broke through the $40 ceiling that had lasted for two decades. Crude peaked above $140 in mid-2008 in the midst of the the financial crisis. A second downturn in oil during 2014 has pushed oil below $50 for the first time since spring 2009 and, in the process, has broken a rising support line drawn under its 1998/ 2009 lows. That raises the strong possibility that crude will keep dropping until it reaches major chart support. There are two candidates for providing that support. The first is the $40 level which was the prior peak formed during 1990. That's because prior major peaks usually act as support on subsequent selloffs. That's why the horizontal line drawn over $40 turns from red to green after 2004. Prior resistance usually becomes new support. The other possible downside target is the low formed during 2008.
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Chart 1
CRUDE COULD RETEST 2009 LOW... An even lower potential target for crude oil is the late 2008/early 2009 low in the mid-30s. Chart 2 shows the early 2009 intra-month low at $33.55. That lower target would come into sharper focus if long-term support around $40 is broken. The monthly bars in Chart 3 show a similar downward trend in Brent Crude Oil. The next potential support for Brent is in the $36-$40 region. All three charts suggest that oil has further to drop before reaching potential chart support. That also suggests that the current deflationary threat is far from over.
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Chart 2
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Chart 3
10-YEAR TREASURY YIELD PLUNGES BELOW 2%... Global deflationary forces are pulling government bond yields lower all over the developed world. European and Japanese bond yields are at the lowest level in history, and are pulling U.S. Treasury yields lower as well. Chart 4 shows the 10-Year Treasury Note Yield falling below 2% for the first time since spring 2013. Bond yields are falling because global investors are buying safe haven govenment bonds -- especially higher-yielding Treasuries. [The falling bond yield is boosting rate-sensitive groups like utilities, REITS and homebuilders. Defensive consumer staples and healthcare are also attracting money]. Falling commodity prices are helping to drive that deflationary threat. [Eurozone consumer prices fell to a negative -0.2% for the first time in five years]. So are the rising dollar and falling foreign currencies.
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Chart 4
RACE TO THE BOTTOM IN FOREIGN CURRENCIES ... A stronger U.S. dollar is deflationary because it weakens commodity prices that are priced in dollars. The reason the dollar is rising, however, is because every other currency in the world is falling. Chart 5 shows four of the biggest losers over the last year -- the euro (-14%), the yen (-11%), the Canadian Dollar (-10%), and the British pound (-9%). The Euro and yen are falling because of loose monetary policies in Europe and Japan. The Canadian Dollar and the pound are being hurt by falling energy prices. Falling foreign currencies are the result of weaker economic conditions in their respective countries. The big question is whether the U.S. economy and stocks can keep rising while the rest of the world is sinking.
Chart 5
EUROZONE DIVERGES FROM THE U.S. ... The eurozone is one the world's weakest regions. And it's been diverging from the U.S. over the last year. Chart 6 compares EMU Index iShares (EZU) to the S&P 500. Since midyear, the EZU has fallen -16% versus a 3% gain for the S&P 500. A lot of the eurozone stock weakness is the result of a -13% drop in the euro during the second half of the year. Deflationary fears (coinciding with a -54% plunge in oil) has also contributed to eurozone weakness. Chart 6 carries a couple of messages. One is that drops in the eurozone usually caused pullbacks in the U.S (although much smaller). That was seen during July and again between September and October. The October bottom in the EZU helped launch a strong yearend rally in the U.S. The latest slide to a new three-month low in the EZU has caused some January selling in the U.S. The blue bars show the EZU trying to rebound from support around its October low. That's aiding a rebound in the states as well. That's an important test both for the eurozone and the U.S. Although the U.S has the strongest economy and stock market in the world, it isn't immune from the negative effects of foreign selling. It needs some help from Europe to keep its uptrend intact.
