Commodity Weakness Pulls Down Equities

The positive tone set by economic data yesterday was overwhelmed by a sharp selloff in crude coupled with a case of investor “cold feet” after hearing the constructive and measured tone set by Chair Yellen in her two speeches on the economy. Yellen spoke of diminishing threats to our continued recovery from abroad to healthy consumer spending and employment gains. That said, Chair Yellen still underscored the data dependency of any move.

All three major indices lost ground on the day and did so with a degree of conviction that has been absent from recent trading sessions as volume expanded on both the NYSE (+7.67%) and NASDAQ (+3.11%). The S&P 500 (-1.09%), Dow Industrials (-0.88%) and NASDAQ (-0.64%) all closed at or near the lows of the session. Internals on both the NYSE and NASDAQ were decidedly negative.

The sector Heat Map is not pretty. On Tuesday, it was a sea of green. Yesterday the reverse was the case – a sea of red. Energy (-2.69%) was the loss leader as a result of the 4% selloff in WTI crude on the day. Communications (-1.29%) and Financials (-1.26%) followed. The only sector to close nearly unchanged was Health Care (-0.13%).

ADP’s much anticipated private payroll release for November (+217k) was significantly stronger than what consensus expectations (+155k) were calling for. Additionally, October’s ADP employment gains were revised higher (+196k). November’s private sector jobs gains were the most in five months and were fueled by small business and the service industry. It is entirely possible that we may see a sub 5% unemployment rate come Friday. Though the relationship between ADP and the official job picture has become less directly correlated over the past several years, there does still remain a connection – at least thematically.

Productivity and Costs fall into two segments; non-farm productivity and unit labor costs. In the case of the former, consensus was calling for 2.2 Q/Q change – SAAR, that is exactly what it was. In the case of the latter, consensus was calling for 0.9% Q/Q change – SAAR. The actual reading came in at 1.8%, reflecting a welcome hint of inflation in unit labor costs.

The Fed’s Beige Book framed the health of our economy in an “expanding modestly” framework. In fact, eight of the twelve Fed districts reported modest expansion while the remaining four were labeled as being either steady or moderate. Mention of modestly tightening labor conditions confirmed ADP data and Productivity and Costs from earlier in the session. Net/net, a constructive report.

The EIA Petroleum Status report reflected a tenth straight week of inventory build – though modest. Crude inventories increased 1.2M barrels for the week versus the previous week’s 1.0M barrels. However, gasoline marginal inventories tightened from 2.5M barrels the previous week to 0.1M barrels. Distillates expanded from 1.0M to 3.1M barrels in the period. The weakness in crude however was not a result of the modest build in inventories. It was a result of clear discord among OPEC members meeting over production quotas in Vienna. In recent weeks investors were banking on a degree of production restraint emerging from these meetings but with the members in disagreement over production quotas, it is entirely possible that the restraint in supply that investors were hoping for will not materialize.

As I suggested late last week, the pressure on crude remains and is being driven by themes from over supply to weak global demand growth. Now with discord among OPEC producers any hopes of an imposed limit to production seems unlikely. My call for a break below $40/bbl materialized yesterday. In the process, equity markets found themselves at the mercy of a crude’s weakness.