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 Crude Oil Continuous Contract (CL.F) & S&P 100 Index (OEX.I) vs Russell 2000 Index (RLS.I)

One of the strongest Novembers for North American equity markets in on record and the best month for stocks since July of 2022 wrapped up with an exclamation point last Friday the first of December. This rally has coincided with a big drop in treasury yields and the US Dollar with investors increasingly anticipating that central banks are pretty much done raising interest rates, despite ongoing hawkish comments from central bankers.

The tone of the rally, however, has shifted a bit in the last few days. The Big Cap and Big Tech indices which led the rally like the S&P 100 and the NASDAQ have actually declined slightly, while the small cap Russell 2000 has caught fire. This suggests a common rotation of capital from market leaders down the market cap chain to the laggards as a trend progression is underway. Investors may get a better idea of the state of the world economy and what central bankers are thinking with a big flood of news and meetings expected between now and next Friday. Yesterday the Bank of Canada held interest rates steady and gave a balanced outlook with a softening economy reducing the chances of another rate hike, but ongoing concern about inflation with rising housing costs offsetting falling energy costs apparently enough to keep them from cutting rates in the near term. Next Wednesday the Fed releases its latest interest rate decision, statement, and FOMC member forecasts with the outlook for the future path of Fed Funds likely front of mind for many investors. A week from today, the Bank of England, European Central Bank and Swiss National Bank all hold their last meetings of the year.

The big question facing investors heading into the holidays is whether central banks shifting from hawkish to neutral or even dovish is due to inflation being defeated or because the economy is weakening. Recent reports have been mixed but there is a lot of data coming for investors to chew on. US ADP Payrolls came in soft yesterday. US nonfarm payrolls are due tomorrow, along with wage inflation. US consumer prices (Tuesday) and producer prices (Wednesday) are due ahead of the Fed decision. Next Thursday brings US retail sales for November (including the Black Friday/Cyber Monday weekend) then next Friday, flash PMI reports from around the world may give an initial peek into economic conditions heading into December.

Concerns about China’s economy have moved into the spotlight in the last week. Asia Pacific markets have been among the worst performers lately including Shanghai, Seoul and Taipei, while Hong Kong hit a new 52-week low this week. This uncertainty has also spilled over into commodity trading with Crude Oil and Copper also selling off sharply in recent days. The coming week brings a lot of China economic numbers which may shed more light on the situation including trade data today, inflation numbers on the weekend and retail sales next Friday.

There is a smattering of earnings reports due next week that investors may find of interest including Oracle and Adobe in technology, homebuilder Lennar, and retailers Costco and Dollarama.

In this edition of Equity Leaders Weekly, we look at the current state of the oil price and at capital rotation between large cap and small cap stocks in the US.

Crude Oil Continuous Contract (CL.F)

Crude Oil (CL.F) has come under significant selling pressure in recent weeks. In terms of what is driving this decline, it does not appear to be supply side driven since US inventories continue to decrease, and OPEC+ did extend and increase supply cuts into 2024 even if perhaps not as much as investors had hoped.

This suggests that concerns about demand appear to be weighing on the price. Considering that Copper has also been selling off and Asia Pacific markets have been in full retreat lately, with the Hang Seng (HS.F) hitting a new 52-week low this week, it appears that worries about China’s economy appear to be the biggest factor driving oil at the moment. With a number of big China data announcements on the way, as mentioned above, any surprises or changes in sentiment toward China could impact China-sensitive markets like commodities, Asia Pacific indices and resource stocks.

For Crude Oil (CL.F), a 3% chart is particularly useful for putting short-term moves into their longer-term context. For the last year, CL.F has been trading back and forth in a sideways channel between $66.00 and $94.00. A summer upswing staged a triple top breakout but was unable to get through resistance at the top of the range near $93.95. In recent weeks, oil has sold off sharply, but so far it remains within its current range.

Oil is currently testing the bottom of its current trading range. A close below $65.90 would complete a bearish pending triple bottom pattern and signal the start of a deeper selloff with next potential support at previous lows near $62.12. Initial rebound resistance appears near $78.70 based on a 3-box reversal, then previous highs near $83.50.

The changing relationship between large cap stocks, represented here by the S&P 100 Index (OEX.I) and small cap stocks, represented here by the Russell 2000 Index (RLS.I) is monitored by many investors as an indicator of the health of a trend.

Generally speaking it is widely expected that the troops (small caps) follow the generals (large caps and sector leaders) over the longer term. It’s when gaps or divergences develop that warning signals start to show up. If large caps outperform too much, it suggests that the market trend is getting concentrated in too few stocks, the troops are no longer following the generals and the market is at risk of a reversal. If small caps outperform because they have continued in the same direction while the large caps have turned, it can be seen as a sign of a potential reversal as well.

The current situation, however appears to be one of growing breadth. For much of the year, large cap stocks have been driving the US market higher. There has been a concern among investors that too much of these gains have been concentrated in the so-called “Magnificent Seven” large cap stocks. This month, the relationship between OEX.I and RLS.I has shifted significantly with Triple Bottom and Spread Triple Bottom breakdowns in the ratio between the two indicating a shift in outperformance from large caps to small caps.

In this case with the large cap OEX.I starting to trend sideways and RLS.I, which had been lagging starting to turn upward, this can be seen as a sign of improving bull market breadth, that the troops are starting to follow the generals higher and that capital is rotating normally down the food chain with profits being taken in early leaders and redeployed into a wider range of stocks and sectors.

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