Sound bites: Will stocks slip on sliding oil prices?

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With key US benchmarks making new all-time highs and the INK Canadian Insider Index making another 52-week high on Wednesday, the key question is whether or not the momentum can be sustained. A key positive development for market bulls over the past week has been the participation and leadership of the Financials, with the Thomson Reuters Financials Index jumping 4.16% compared to a 3.04% gain for the S&P 500 as of Tuesday. A good amount of the gains took place early in the week as long bond yields rose on the back of renewed hopes for aggressive global monetary easing. There was plenty of chatter that the Bank of Japan (BoJ) would be considering either a form of targeted lending to effectively assist the central government in financing a large infrastructure plan or "helicopter easing" which we would dub as HE. Under HE, the central bank would send cash payments or loans directly to households, bypassing the credit markets.

Both targeted lending and HE would be bond unfriendly as they help economic actors (either the government or households) essentially bypass the discipline of the credit markets in raising cash for new consumption. Greater consumption could boost inflation expectations putting upward pressure on long-term bond yields. Rising long-term rates could help boost bank margins, while defensive dividend paying stocks could come under pressure when faced with greater competition from the bond markets in the hunt for yield.

Meanwhile, the prospect of greater global consumption could put a bid under the economically sensitive resource, industrial, and consumer sectors. In short, the prospect of either targeted lending or HE seem to serve up all the ingredients needed for a reflationary breakout of stocks. Should such a scenario unfold, insiders are signalling that banks could be a big winner. Our INK US Banks Indicator remains above 100% meaning there are more stocks with key insider buying than there are with selling.

But are market expectations justified for such a radical round of monetary intervention? We will not have long to wait to see if market expectations are justified as the next BoJ meeting takes place on July 28th and 29th. Indeed, it is probably worth noting that the only other area of the US market with an indicator above 100% is in Casinos and Gaming.

Will oil prices give markets the slip?

Right now, while there has been much talk about how the fallout from Brexit could trip up stocks, little has been said about the sudden weakness in oil prices. In fact, oil prices are now struggling around two month lows. According to the Paris-based International Energy Agency, daily OPEC oil production remains above 31 million barrels a day in June. On the same day, the Energy Information Administration in the United states reported that US production including Alaska rose last week. Meanwhile, Canadian production is now coming back on stream after the Alberta wildfires. Before the fires, daily production was expected to rise by the end of the year. While we may have to wait to see if that expected production growth will still materialize, it seems that $50 oil provides plenty of incentive for North American production to come back on stream and ramp up supply, potentially capping any breakout.

For their part, American oil and gas insiders are sending cautious signals about a sector revival. The INK US Energy Indicator has now slipped below the 40% (2.5 stocks with key insider selling for every one with buying) mark, helping to pull broad sentiment lower. With US Energy insider sentiment below 40%, we are downgrading the sector's sentiment reading to overvalued. Within the sector, the group with best insider sentiment reading is the refiners with our Refining and Marketing Indicator at the 100% mark. In contrast, Exploration & Production sentiment has collapsed, with our indicator now below 20%.

Depressed E&P insider sentiment combined with oil prices may well start to reignite fears about financial risks in the sector. Should that happen, US banking exposure to the oil patch could once again come into focus pouring cold water on the recent rally in the Financials. If both Energy and Financials stocks were to stumble, it is hard to see how markets could continue their trek to more highs without first taking a rest.

This article includes excerpts from the US Market INK Report distributed to clients on July 13, 2016.

Listen to Ted Dixon on Roundhouse Radio FM 98.3 every Thursday for his weekly financial markets commentary at 7:30 am Pacific Time. If you missed the live broadcast, catch the replay here http://bit.ly/29HbSTC.

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