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Oil expiration and earnings are big movers for Tuesday

Downside risk to oil prices in Q2 : Pro
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Downside risk to oil prices in Q2 : Pro

Amid the deluge of major earnings reports, traders will also be keeping an eye on the mercurial oil market, as U.S. oil futures for May expire Tuesday.

Earnings are expected from Verizon, United Technologies, Travelers, DuPont, Kimberly Clark, Yum Brands, Yahoo, Chipotle Mexican Grill, Lockheed Martin, Baker Hughes and Cree, to name a few. It's quiet on the data front, so earnings reports will dominate the early hours.

Stocks bounced Monday after the market ripped lower on Friday on reports that Chinese regulators would crack down on margin lending. But an unexpected promise of stimulus from China's central bank boosted equities, giving the U.S. market strong gains.

Traders work on the floor of the New York Stock Exchange.
Brendan McDermid | Reuters

After gushing higher last week, oil futures, meanwhile, rose again Monday on the China news and the view that U.S. oil production is beginning to slow. The People's Bank of China Sunday dropped the reserve requirement ratio for banks by 100 basis points.

Oil futures at one point traded lower earlier Monday after Saudi Arabia said it was going to continue pumping 10 million barrels a day in April, above its recent levels, but news on U.S. storage in Cushing, Oklahoma, the physical storage hub for Nymex futures, helped send prices higher.

"Reports in the market are that it looks to be a drawdown in Cushing inventory this week," said John Kilduff of Again Capital. "The rig count was down again on Friday, cut in half from last year's level." Rig count fell for a 19th straight week, falling to 734 active oil rigs from a peak of 1609 in October.

Energy Stocks – Time to buy?

The question for stock strategists is whether it's time to wade deeper into the oil sector, though energy strategists are still somewhat divided on whether the market has seen its lows for the year. One issue has been the storage capacity at Cushing, at record levels and nearing capacity. Should it reach capacity, the market has feared it would trigger a fire sale of U.S. crude at much lower prices.

Fadel Gheit, senior energy analyst at Oppenheimer, believes oil has already bottomed and the gain in energy stocks so far this year reflects an oil price in the $70s per barrel.

"They are all reflecting $75 oil. Half of the domestic producers will have losses this year," said Gheit. "They're all overvalued but I'm telling people to buy oil stocks because I think oil prices will rise." Gheit said when oil was at its highs last June, the stocks reflected $95 oil.

But Deutsche Bank strategists Monday took the opposite view and believe oil stocks are reflecting too much optimism for an earnings rebound, both in timing and level. In a note, they said the oil price rally provides another exit opportunity in energy names.

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The firm is underweight the sector, and the analysts note oil would have to average at least $75 a barrel to achieve implied 2016 earnings for the S&P energy sector of about $100 billion on an assumed price-to-earnings ratio of 15.

Deutsche expects earnings of about $50 billion in 2015 and $75 billion in 2016, with $100 billion possible in 2017.

However, some firms believe targeting specific subsectors of energy is the way to go.

"I think oil is in the process of bottoming. It's conceivably possible you get another move down this summer if you have some storage problems," Russ Koesterich, BlackRock's Global chief investment strategist. "The reality is you are taking a lot of production offline in the U.S."

"My guess is a year from now, oil is in the $60s, not $30s," as some forecast, said Koesterich.

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In the energy sector, Koesterich favors large, integrated oil companies, over other energy subsectors. "One, they're very cheap, relative to the broader market. They're actually a reasonable dividend play, rather than pay up for utilities and staples. They're a bargain," he said, noting the bottoming in oil will continue to be a volatile process. "They have a lower beta to oil than other parts of the energy sector."

The large integrated companies include names like ExxonMobil and Chevron.

The energy sector has contributed to expectations for the first decline in corporate quarterly earnings in six years. According to Thomson Reuters, earnings as of Monday were expected to decline 1.9 percent for the first quarter, and energy profits are expected to be down 63.5 percent. Seventy-six percent of companies so far are beating lowered earnings forecasts.

The stock market has largely looked at the rebound in oil prices, after a 50 percent decline, as a positive because of the impact on earnings. West Texas Intermediate crude futures for May expire Tuesday, and they were trading above $56 per barrel Monday. June futures, which will become the front month, were trading near $58 per barrel. Futures hit a low near $42 in mid-March.

"I don't think oil being up is necessarily a positive. People were worried about the impact of oil on earnings. It's still a fact that oil being down so much this year-to-date helps the market and helps the global economy," Koesterich said.

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"To me, the bigger problem for the stock market is you had a really soft Q1. The Chicago National Activity Index came out this (Monday) morning. It was pretty soft. The economy is not bouncing back," he said. "With this stronger dollar, you're having a pretty mediocre earnings season."

He said the negatives of energy for the broader market have been overstated. "The stock market can rise if energy is struggling. The energy sector is 8 or 9 percent of the overall market cap of the S&P 500. Consumer discretionary and staples is more than 20 percent. The benefit to the consumer companies (of lower oil) should have a larger overall impact on the stock market than the energy companies," he said.

Koesterich said he expects the stock market to remain volatile. "I think the market is going to be much more choppy. We came in to the beginning of the year, expecting the stock market to have single-digit gains. I would stick with that," he said, adding he has been recommending adding to international stock holdings.

Sam Stovall, chief equity strategist at S&P Capital IQ, in a note Monday, cautioned investors to move back into the energy sector selectively after the price bounce back.

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"The natural question at this point is, "Is it time to jump back into energy?" Our one-word answer is, "Selectively." There are 101 energy sector stocks in the U.S. and Canada followed analytically by S&P Capital IQ equity analysts. Despite the significant selloff during the past year, fewer than one-third of these are worth buying, in our opinion," wrote Sam Stovall, chief equity strategist at S&P Capital IQ.

"Many headwinds remain. Indeed four of the S&P 1500's seven subindustries have negative fundamental outlooks, according to S&P Capital IQ equity analysts, while two have neutral outlooks. Only one—Oil & Gas Storage & Transportation—carries a positive outlook," Stovall wrote. In the sector, S&P likes Holly Energy Partners, Tsakos Energy Navigation, Plains All American Pipeline, and Sunoco Logistics Partners.

Of the seven subindustries within the S&P 1500 Energy Sector, S&P has a negative outlook on coal and consumable fuels, oil and gas drilling, oil and gas equipment and services and oil and gas exploration and production. It's neutral on integrated oil and gas, and oil and gas refining and marketing groups.

Stewart Glickman, the S&P energy sector group head, notes: "Our fundamental outlook for the oil and gas storage and transportation subindustry for the next 12 months is positive. We expect fee-based pipeline and terminal operators to continue to expand earnings in excess of anticipated real U.S. GDP growth, as profitability of such operators depends more on volumes than on pricing."