Where Do Stocks Go After Doha?

The OPEC meeting in Doha, Qatar, has dealt crude oil futures a blow

Senior Vice President of Research
Apr 18, 2016 at 10:16 AM
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"The SPY's trading pattern is similar to the August-September action that preceded a double-digit percentage rally."
-- Monday Morning Outlook, Feb. 16, 2016

"The positive news was the late-day Thursday bottom just above the SPY's big put open interest at the 180 strike. The reversal was driven by perceived positive catalysts, the first being news that crossed the wires that an Organization of the Petroleum Exporting Countries (OPEC) oil minister expressed desire for a production cut -- which stemmed sharp losses in the oil market."
-- Monday Morning Outlook, Feb. 16, 2016

"… if the broader similarities continue, and bulls can push SPY above resistance from its 40-day moving average, a potential target is $207 -- which is where it peaked just ahead of the sharp sell-off that began in late December."
-- Monday Morning Outlook, Feb. 22, 2016

This week, we take you back to February, when the market was carving out its recent lows. During those "dark days" of February -- and as the market climbed from its trough -- we discussed the remarkable similarities between the SPDR S&P 500 ETF Trust's (SPY - 207.78) price action and that of August-September, pointing out specifically that we could be on the verge of a double-digit rally.

Moreover, we observed the extremes in negative sentiment that had built up -- in some cases extremes not seen since the bear-market bottom in 2009. The bottom line was that if the negative sentiment we had observed in February was to unwind, tremendous buying power would be unleashed.

Fast-forward to the present, on the heels of a SPY rally of more than 13%, and back to the December highs that preceded a correction. And, over the weekend, all eyes were on a meeting among oil ministers in Doha, Qatar, where leaders did not agree to a freeze in oil production.

Have we come full circle? As we pointed out in one of the excerpts above, a catalyst that helped reverse the market carnage in February was an Organization of the Petroleum Exporting Countries (OPEC) oil minister discussing the possibility of a production cut. The news put a floor on oil, as short covering sparked an impressive rally in the oil futures market and equities in the oil-and-gas sector.

Short covering created an increase in the net long position of large speculators in the weeks preceding an oil production meeting this past weekend in Doha, Qatar

Net long positions April 18

As you can see from various observations I made on Twitter during the course of last week, oil and major equity indexes ended last week at or just below resistance levels. By contrast, the CBOE Volatility Index (VIX - 14.48) was trading at potential support.

With no deal on a production freeze, oil futures are down almost 4% this morning, but stocks have erased a pre-market deficit. One might argue that there is a heightened risk that volatility moves higher as resistance on various equity benchmarks come into play. Shorts in the crude oil market may grow bold again and drive oil- and energy-related stocks lower.

Moreover, a move higher from half the VIX's calendar-year high is now a stronger possibility. In fact, April VIX options are set to expire Wednesday morning, and April VIX futures (15.00) are hovering around peak put open interest at the 15 strike. The buying of VIX futures could be magnified somewhat from the unwinding of hedges related to the expiration of these put options.

April VIX futures open interest configuration -- options expire this Wednesday

April VIX futures open interest April 18

But, as I observed on Twitter last week, the latest short interest data from the exchanges was released last week. This is the first time since the February bottom that we saw a decrease in S&P 500 Index (SPX - 2,080.73) component total short interest since the February bottom. The latest report captured data through the end of March.

For bulls, the good news is that if this short covering continues, it should serve as a basis of support for the market and perhaps allow it to disconnect from negative headlines this past weekend, with respect to the energy sector. As you can see on the chart immediately below, there is plenty of short-covering potential on SPX component stocks, as total short interest is significantly above last year's lowest levels. 

SPX short interest

So stay tuned. On the one hand, the broader market could become consumed with what appears to be a negative reaction in the oil market to this past weekend's meeting in Doha. After all, it was a rally in oil that was coincidental with the February broad-market bottom.

On the other hand, this news may very well be digested positively, which would not be a surprise either. After all, one would think that lower oil prices on the prospect of healthy supply would be taken more in stride than lower oil prices driven by a collapse in demand.

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