Developed Countries

Overweight Household products stocks are in a V-shaped recovery since the early-2018 market peak and these safe haven stocks have more upside in times of tumult (middle panel) despite their pricey valuations (bottom panel). Demand for staples remains robust despite the growth slowdown and the current message from the latest PCE report calls for additional relative share price gains (second panel). Not only domestic demand is upbeat, but industry exports are also on a roll, in spite of the U.S. dollar’s recent appreciation (fourth panel). This suggests that non-discretionary items remain in high demand in the rest of the developed world and the emerging markets despite the loss of consumer pricing power. Bottom Line: We reiterate our overweight stance on the S&P household products index. The ticker symbols for the stocks in this index are: PG, CL, CLX, KMB, CHD. ​​​​​​​  

How important is the potential thawing of the Sino-U.S. trade war to oil markets?  On a scale of 1 – 10, this goes up to 11 (Chart of the Week). Brent’s and WTI’s one-day rally of ~ 5% on Tuesday, followed by a 4.5% sell-off on Wednesday, is a testimony to the importance these markets place on the evolution of the Sino-U.S. trade war, and anything that suggests a change in the status quo.1 The rally was an almost-immediate response to the announcement the U.S. would delay until December 15 the imposition of tariffs on ~ $160 billion of $300 billion of goods that become effective September 1. The tariffs were announced August 1 by President Trump. Wednesday's sell-off was triggered by weak global economic data and building U.S. crude stocks. It also was a wake-up that nothing substantive was advanced to resolve the Sino-U.S. trade war. The rally indicates pent-up demand awaits a resolution of trade uncertainties. In this report, we introduce our new proprietary Nowcast model of EM commodity demand.2 We also look at the overall macro backdrop for commodity markets, which is largely supportive, with most of the world’s central banks moving to a recession-fighting mode.3   In addition, we could get a deal between the U.S. and China following the resumption of tariff negotiations in Washington come September, which allows some resumption of trade. We have little doubt markets would welcome such an outcome. However, we remain skeptical of the deeper issues separating the two sides – e.g., IP protection, an end to forced technology transfers – will be resolved in the near future. Highlights Energy: Overweight. Saudi Aramco held its first-ever investor call this week, disclosing it earned close to $50 billion in 1H19. Earnings were down ~ 12% in the period, according to the company, partly as a result of a 4% decline in realized prices for crude oil vs. 1H18. This is a relatively small decline vs. the 7% and 12% 1H19 y/y declines in Brent and WTI, over the same period, reflecting the Kingdom’s premier position as the largest exporter of medium and heavy crudes in the world. These streams are in short supply relative to the light-sweet crude being produced in the U.S. shales. Base Metals: Neutral. Copper also got a lift from renewed trade-talk hopes, rising 2.3% on the back of the unexpected trade news from the Trump administration earlier in the week. Many of the products exempted by the Office of the U.S. Trade Representative are electronics – cell phones, laptop computers, video game consoles, and computer monitors – which will marginally support copper prices, and Christmas retail sales. Copper held on to most of its gains Wednesday. Precious Metals: Neutral. Gold and silver sold off following the U.S. trade representative’s announcement, but recovered later in the trading day, and Wednesday. Gold continues to trade above $1,500/oz, while silver trades over $17/oz. We remain long both metals as portfolio hedges against policy risk. Ags/Softs: Underweight. With the exception of corn, grains and beans mostly rallied on the trade news, with soybeans ending the day up 1.2% Tuesday. Corn traded down 6.1% Monday and a further 5.0% Tuesday, following the USDA’s WASDE report, which indicated acres planted would fall by less than analysts estimated going into the Monday morning release of the department’s supply-demand estimates, according to agriculture.com. Feature Commodity markets are noted for their ability to cover a year’s worth of price movement in a matter of days. The past two weeks in the oil markets have not disappointed, as the Chart of the Week attests. Despite the volatility introduced by exogenous policy shocks, we remain constructive on crude oil. The underlying resilience in the growth of EM economies, which drives commodity demand generally, is apparent in various gauges we’ve developed to track something close to current conditions in markets. In addition, as noted above, fiscal and monetary policy globally remains supportive of commodity demand. While growth may not match the halcyon pre-GFC days shown in the top panel of Chart 2, growth still is strong and, importantly for commodities, is coming off a higher base level.4 Broader indicators – e.g., global and country-specific LEIs – support our expectation for improved EM growth, which, ultimately is what drives commodity demand. We are compelled to note considerable uncertainty around the prospects for global growth – particularly for EM GDP growth – exists in markets and within BCA Research. Our Special Report on these divergent views elegantly presents these differences, and we highly recommend it to our readers. Fundamentally, we align with the bulls, who argue global growth can be expected to rebound this year, for reasons we cite above. The bears in BCA, which include our Emerging Market strategists, have a different view to ours, particularly on EM domestic demand. The bears expect a further deterioration in global economic activity or a delayed recovery. As a result, they expect additional downside in stocks and risk assets – including commodities – and outperformance of defensives relative to cyclicals, low safe-haven yields, and a generally stronger dollar.5  EM GDP Resilience Our BCA EM Commodity-Demand Nowcast model points to an underlying recovery in oil demand, despite the continued policy-induced volatility in prices (Chart 2). This model is a weighted index of our Global Commodity Factor (GCF), Global Industrial Activity (GIA) Index, and EM Import Volume (EMIV) models (Chart 3).6  Chart 2BCA EM Commodity-Demand Nowcast Suggests Oil Demand Rebounding Chart 3BCA EM Commodity-Demand Nowcast Components   Chart 4Global Growth Poised To Resume The GCF uses principal component analysis to distill the primary driver of 28 different commodity prices traded globally. The GIA index uses trade data, FX rates, manufacturing data and Chinese industrial activity statistics, which can be updated monthly. Lastly, the EMIV model is driven by EM import volumes reported with a two-month lag by the CPB in the Netherlands, which can be updated to current time using FX rates of economies highly sensitive to EM trade. Our BCA EM Commodity-Demand Nowcast is strongly correlated with y/y growth in nominal EM GDP and non-OECD oil consumption, as Chart 2 shows. This highlights the strong connection between EM GDP growth and oil demand growth. This also is critical to price formation – indeed,  our Nowcast is highly correlated with crude oil prices, which explains why EM GDP is our principal demand variable in forecasting oil prices (Chart 2, bottom panel). Other, broader indicators – e.g., global and country-specific LEIs – support our expectation for improved EM growth, which, ultimately is what drives commodity demand (Chart 4). However, these can change as local economic activity changes.7 One important thing to note, however: While China’s nominal import volumes are weaker y/y, its volume of crude oil imports (Chart 4, top panel) are growing. Partly this is the result of strong refinery margins; but there is a risk too much product will be produced, which could saturate Asian refined-product markets.8 Bullish Crude Oil Term Structure While price levels have been hammered lower by trade policy uncertainty and weekly pivots in direction, the Brent and WTI forward curves remain backwardated (Chart 5). This normally indicates market tightness – i.e., refiners are willing to pay more for prompt-delivered crude than for deferred delivery. Crude oil markets continue to be buffeted by policy shocks – particularly in regard to the Sino-U.S. trade war. Chart 5Crude Oil Forwards Remain Backwardated This is consistent with our reading of the underlying supply-demand dynamics of the crude market. It is important to note the backwardation in these forward curves weakened almost every month since the beginning of the year. This suggests demand slowed – the market is tight, but closer to balanced, and not in as large a supply deficit as it was expected earlier in the year. We expect OPEC 2.0 to continue to maintain production discipline, and for demand to turn up in 2H19.9 In addition, we continue to expect strong demand in 2H19 and in 2020 as we’ve noted above, given the supportive fiscal and monetary backdrop globally. Bottom Line: Crude oil markets continue to be buffeted by policy shocks – particularly in regard to the Sino-U.S. trade war. Despite these shocks, demand for crude is holding up, although it still is lower than what we expected previously – along with the EIA and IEA, we’ve been revising demand lower in our last three monthly Global Oil Balance assessments. Demand is now supported by monetary and fiscal policy easing globally. However, escalation in trade tensions could bring demand down again. Indeed, an escalation in Sino-U.S. trade tensions could push this to a lower equilibrium. It is important to point out our Nowcast is a coincident indicator, and that most of our series' last data points were observed in July, which is before the latest escalation in trade tensions. We could see a move down in some of our indicators next month. To be clear, we are not sounding an all-clear on the trade front, although we are seeing signs of recovery from relatively high base levels of EM GDP activity.   Robert P. Ryan, Chief Commodity & Energy Strategist rryan@bcaresearch.com   Hugo Bélanger, Senior Analyst Commodity & Energy Strategy HugoB@bcaresearch.com   Footnotes 1      Please see USTR Announces Next Steps on Proposed 10 Percent Tariff on Imports from China, issued by the Office of the United States Trade Representative August 13, 2019. The USTR’s press release appears to be something of an olive branch, noting, “On May 17, 2019, USTR published a list of products imported from China that would be potentially subject to an additional 10 percent tariff.  This new tariff will go into effect on September 1 as announced by President Trump on August 1.”  This suggests the opening of a possible compromise ahead of trade talks set to resume next month. 2      As discussed below, our BCA EM Commodity-Demand Nowcast combines three of our proprietary models gauging EM commodity demand.  Please see Getting Long Silver, To Hedge Exogenous Shocks, published by BCA Research’s Commodity & Energy Strategy August 8, 2019.  It is available at ces.bcaresearch.com. 3    Our prior remains it is highly unlikely the PBOC or the Fed will let their economies weaken substantially without deploying additional monetary stimulus.  In addition, we believe Chinese policymakers will hold off on major stimulus in the next couple of months to get thru National Day, which will allow them to deploy further fiscal stimulus after October and next year, in the event the trade war and currency war worsens.  We also draw attention to the fact that, globally, central banks all are acting as if they’re already fighting a recession – last week, three central banks announced further easing (India, New Zealand, Thailand), following similar action by the Fed and Asian central banks (South Korea and Indonesia).  A full-blown trade war between the U.S. and China would be tumultuous, but, after the dust settles, global supply chains would have to be rebuilt or augmented, as trading blocs centered on the respective antagonists regrouped and reorganized their trading relationships and supply lines. 4     Using World Bank quarterly GDP figures, we calculate Emerging and Developing markets’ GDP will be up close to 74% between 2007 and 2019, averaging $7.24 trillion in constant 2010 USD this year. 5      We urge our clients to read this Special Report, What Goes On Between Those Walls? BCA’s Diverging Views In The Open, published by BCA Research July 19, 2019. 6       The nowcasting index uses the weighted average of each component’s coefficient of determination that falls out of a regression against EM GDP growth. Our analysis indicates EM oil demand is driven by EM GDP growth.  For additional information on the separate gauges, please see Getting Long Silver, To Hedge Exogenous Shocks, Expanded Sino – U.S. Trade War Could Be Bullish For Base Metals published by BCA Research’s Commodity & Energy Strategy August 8 and May 9, 2019.  Both are available at ces.bcaresearch.com. 7      We note Indian economic activity is slowing due to strains on the shadow-banking system in that country.  This bears watching, as India is the second largest EM economy we track in our oil-demand estimates.  Please see India's passenger vehicle sales drop at steepest pace in nearly two decades, published by in.reuters.com August 13, 2019. Auto industry representatives are pushing for government support to address the sales downturn.  S&P’s BSE index measuring the health of Indian banks is down 23% ytd.  8     Please see UPDATE 1-China's July crude oil imports rise as refiners ramp up output published by reuters.com August 8, 2019. 9      We are updating our supply-demand balances and prices forecasts for Brent and WTI next week. For our most recent forecast, please see Weak 1H19 Oil Demand Data Fuels Market Uncertainty published by BCA Research’s Commodity & Energy Strategy July 18, 2019.  It is available at ces.bcaresearch.com.   Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades TRADE RECOMMENDATION PERFORMANCE IN 2019 Q2 Commodity Prices and Plays Reference Table Trades Closed in 2019 Summary of Closed Trades

While the stock market cheered the news that President Trump will postpone the tariffs on certain Chinese made goods to December – slightly reminiscent of Trump’s Mexican tariffs backtracking – we continue to heed the negative messages from a number of our indicators and remain cautious on the broad market on a cyclical time horizon. Our Equity Market Internal Dynamics Indicator (comprising economically sensitive equity sector tilts, EMIDI) continues to emit an unambiguous sell signal. Historically, this indicator peaks in advance of the broad market as it sniffs out trouble ahead of the overall market (see circles, top panel). With regard to troughs, the EMIDI’s track record is more coincident than leading. Beyond this negative omen, stalling earnings also suggest at least a digestion period in the SPX. As a reminder the last time EPS hit a wall near $118/share for three years running between 2014 and 2016, the SPX moved laterally with a lot of volatility post the August 11th, 2015 Chinese renminbi devaluation (bottom panel). Fast forward to today and it appears as though the overall market cannot clear the $165/share level. Sell-side analysts are also feverishly downgrading Q3/2019, Q4/2019 and overall 2020 EPS, warning that the SPX has more downside. Bottom Line: Absent a turnaround in profits we remain cautious on the broad equity market on a cyclical 3-12 month time horizon. ​​​​​​​