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By HaleStewart January 6, 2015 8:15 am
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Is Oil's Sell-Off Getting Overdone?

     Over the last few months, oil's sell-off has been the story to talk about on Wall Street.  However, let's put this situation in perspective by looking at the long-term weekly chart:

1.) The sell-off has been extreme.  Prices have moved sharply lower since the beginning of July.  When prices hit the EMAs, they move lower.  There were a few attempts at a rally in September, but since then the direction has been down.  This looks like panic selling, where a majority of asset holders receive news that the asset is fundamentally mis-priced, at which time everybody places sell orders.

2.) Prices have moved convincingly through three long-term support levels -- prices at ~65, ~60 and the mid-50s.  

3.) Prices are now approaching levels last seen in the "Great Recession."  Let's stop right here and ask a question: does that valuation make any sense?  During the GR the entire world was in the throes of the most extreme financial contraction of a generation (in fact, several generations).  Entire industries (banking and autos) were getting bailed out.  Central banks were contemplating QE programs; governments were engaging in fiscal stimulus. 

     Are we now in a similar situation?  Not yet.  China is slowing, but is still growing at a 7% rate.  Japan will probably come out of their recession in the next two quarters.  The EU is hovering at 0% growth, but they are not crashing through the floor.  The biggest problem is Russia, as the combination of cheap oil and economic sanctions will lead to a recession next year.  But they're a special situation.

     And -- when was the last time oil was the leading indicator?  Never.  In fact, oil price spikes have been a primary cause of most post-WWII recessions as documented by professor James Hamilton, not the other way around.

     But although we aren't in the middle of a financial crisis similar in depth and breadth to the previous recession, oil is pricing in such a condition.  I would argue that we should start to consider the possibility that oil's sell-off is getting overdone.

Hale Stewart is a former bond broker who has been writing about economics and financial markets since 2006 on the Bonddad Blog.  He is also a tax attorney with a domestic and international practice while also forming and managing captive insurance companies for US companies.   You can follow him on twitter at:@captivelawyer 

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