Falling oil prices could become a factor for stocks if crude cracks $40 per barrel.
Oil will be a focus in the markets again Wednesday, with U.S. oil inventory data expected at 10:30 a.m. ET.
Oil crossed into bear market territory Tuesday and is now off 20 percent from January's high. Oil futures were hit hard Tuesday, as the market worried about oversupply. West Texas Intermediate futures for August settled at $43.48, down 2.1 percent.
Analysts expect Energy Information Administration data Wednesday to show a decline in crude supply of 2 million barrels, according to Platt's. Gasoline is expected to fall 750,000 barrels and distillates, lower by 250,000 barrels. The data can be volatile and market moving.
"If it's a large build, it will be a problem," said Art Cashin, director of floor operations at UBS. He said the market is watching $40 since that is the level where many U.S. drillers can no longer make a profit.
"I think if oil definitely breaks $40 into the $30s, I think it will impact stocks," said James Paulsen, an independent market strategist. "I don't think it's game over, but I think stocks have to think about it a little harder."
Paulsen said it would be a double negative if a big decline in oil coincided with a batch of weak economic data. He noted the Citigroup economic surprise index has fallen to a six-year low, based on a significant number of negative surprises recently.
"At the same time, you have bond yields — they kind of quit going down, but they're not going back up. You put that in the mix, and you put it all against the backdrop of the Fed on the rate train north," he said. The combination of weaker data, slumping oil and low yields could be raising a flag on the broader economy at a time the Fed may hike rates.
But Paulsen said it could be that the surprise data is going to start turning positive and the recent move higher in financials may be one of the signals for that.
Besides the energy data, there are existing home sales at 10 a.m. which will be watched after recent housing starts came in below expectations last week. They are expected to decline by a half percent.
The key tech stocks in FANG — Facebook, Amazon, Netflix, and Google parent Alphabet — were lower Tuesday. The group had bounced back Monday, after steadying Friday.
"I think the tech stocks are going to keep underperforming for a period," said Paulsen. However, the fact the market made it to new highs, while tech moved lower sends a positive signal for stocks, he said.
"I think we might just go sneakily higher here, and we might find out it's doing that because of the data picking up," he said.
He does not expect a summer swoon, as many analysts do.
"May 31 to August 31 is one of the best periods for the market," said Paulsen, noting that contrasts with the "sell in May" theory, where stocks are weaker between May 1 and Nov. 1.