Thankful for Irrational Traders

By Jani Ziedins | End of Day Analysis

Dec 10
S&P500 Daily

S&P500 Daily

End of Day Update:

Thursday was the first up-day this week as the S&P500 struggles to resist oil’s slide to multi-year lows. But “up-day” is a relative term since we only finished four-points to the positive following three-days of losses that shed more than 40-points. Today’s volume was the weakest since we topped a couple of weeks ago. But even more ominous was the lethargic intraday trade over the last-two sessions where early strength fizzled and we closed near the lows. If this market was oversold and poised to launch higher, early strength would have sent us on our way. It is hard to be constructive when every rebound is overwhelmed by another wave of selling.

Oil has been in a nearly one-way selloff since early October. While everyone has largely been aware of the low oil prices, concern didn’t get acute until Monday when we broke under $40 for the first time in seven-years. This development moved oil prices from the commodity page to the front-page.

In Tuesday night’s post I wrote about how nonsensical it was for the market to lose its mind as oil went from down 60% to down 63%. Really? We can handle a $60 drop, but $63 is just too much for the market to bear? How much more damage can another $5 or $10 fall do when we already shed $60 over the last year and some?

Previously there was a legitimate argument that falling oil prices was due to a weakening economy and dropping demand. While there is a nugget of truth here as the global economy slows, it is becoming increasingly obvious that oil’s biggest problem is supply, not demand. The lower oil prices fall, the more producers are forced to pump to compensate for the lower prices. This isn’t a consumption problem, it is a structural problem for an industry with high capital expenditures and low operating costs. With pumping prices around $20 per barrel, producers are incentivized to pump as much as they can even at $37 per barrel. And this line of thought played out at last week’s OPEC meeting where the group failed to agree to production limits to prop up prices.

All of this means equities tight correlation to oil prices this week is total B.S. If financial contagion, multiple acts of terror, a plunging Chinese stock market, and all the other bearish headlines we survived this year, should we really fear another $5 dip in oil? But this is the logical argument and it often takes the market time to come around to the obvious answer. Given the awful way we traded this week, that appears to be the case. There is no merit to this selloff, but that doesn’t stop reactive and emotional sellers from joining the herd. But I cannot complain too loudly because without the crowd’s irrational trading decisions, it would be far harder to make money. If people want to sell me perfectly good stocks at a discount, who am I to argue with them?

While this dip is buyable, we are not quite there yet. Wednesday’s and Thursday’s weak trade tells me there is a little more downside before we reach a capitulation bottom. We are hovering so close to recent lows that a dip under these levels is almost inevitable. If we break support and rebound sharply on high volume, that will be our sign the fever has broken and we can jump back in.

Of course the next major headline is the Fed meeting next week, but I’ll save that analysis for next time.

Jani

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About the Author

Jani Ziedins (pronounced Ya-nee) is a full-time investor and writer who has successfully traded stocks and options for more than a decade. He earned a B.S. in Mechanical Engineering from the Colorado School of Mines and an MBA and M.S. Marketing from the University of Colorado Denver. His prior professional experience includes manufacturing engineering at Fortune 500 companies, structural engineering, small business consultant, collegiate instructor, and managing investment real estate. He is now fortunate enough to trade full-time from home, affording him the luxury of spending extra time with his wife and two young children.