Commodities & Energy Sector

Somewhat like 1998, the dilemma for the Fed is that the labor market is approaching full employment and may justify eventual interest rate hikes.

Refining stocks have been slammed this year, and we expect more pain ahead. Companies had continued to operate at full throttle, as measured by the relentless advance in refinery production (second panel), likely reflecting expectations for ongoing demand strength and decent export markets. However, both gasoline and refined product inventory have been steadily building since last year, warning of excess inventory accumulation. Worse, refined product consumption is contracting, underscoring that it will take output cuts to work through the supply glut. Refiners have an incentive to pull back, given that refining margins are essentially nil, but the implication is a potentially sizeable profit hit. The index is not priced for an earnings downturn. We maintain our high-conviction underweight. The ticker symbols for the stocks in this index are: MPC, PSX, TSO, VLO. bca.uses_in_2016_02_12_001_c1 bca.uses_in_2016_02_12_001_c1

A rebalancing of oil supply and demand will lead to higher crude prices later this year. The Canadian dollar and Norwegian krone will benefit, but it is still too soon to buy these currencies versus the U.S. dollar. For now, we prefer to play the long side in the CAD and NOK <i>via</i> cross trades.

Plunging commodities have been driven by increased supply and falling investor demand, not a major downshift in physical demand. Stay neutral global equities. The earnings outlook remains uninspiring, but bottoming oil prices and continued monetary stimulus support valuations. The selloff in global bank shares reflects NIRP-related "income statement worries", not "balance sheet concerns" linked to deteriorating credit quality. Downgrade Treasury notes to neutral. The rally in bonds has brought 10-year yields near our long-standing, out-of-consensus target of 1.5%. 

Rebalancing in the oil market later this year will arrest the negative feed-back loop driving markets' inflation, interest-rate and FX expectations, particularly for non-OPEC oil-exporting countries.

Global trade is plummeting as commodity prices remain depressed and emerging markets unravel. Even if oil were not plumbing new lows, we would remain bearish on EM economies, where poor governance and low efficiency suggest that more crises will rear their heads. Above all, we are watching China for policy clarity. After seizing 14% of global exports in recent years, it is now exporting surplus goods into an already deflationary world. Protectionism - not a coordinated response among leading countries - is the likely result. In essence, we reiterate our theme that globalization has peaked. Along the way, we call attention to five geopolitical "Black Swans" that <i>no one</i> is talking about.

This week we are publishing a new thematic chartpack <i>The BCA China Industry Watch</i> in an effort to monitor the growth profiles, balance sheet strength and stock market performances of major Chinese industrial sectors.

Stay cautious. The Fed is only beginning to acknowledge what markets already realize. Eventually, they will back off, which reduces the odds of a further sustained equity decline. So far, however, the central bank is lagging deflationary forces acting on the U.S. economy, markets and profits. The weak ISM surveys are consistent with this. The risk is that employment follows suit.

Oil markets will continue to be buffeted by Russian overtures to OPEC suggesting a desire to orchestrate a production cut-back, while uncertainty over the Fed's next move keeps markets on edge.

Energy service stocks are so oversold and cheaply valued that contrarians are chomping at the bit to establish long positions. Is it time? In previous research, we have cited a number of common elements at bear market troughs: a cresting in total OECD oil inventories; a peak in global crude oil production; and a rising global oil rig count. These conditions do not yet exist, and OPEC seems unlikely to turn off the taps, lest cede market share that they have worked so hard to protect. However, the downturn in U.S. oil production may be providing a preview of what to expect in the rest of the world, particularly as credit and equity market stress robs producers of the access to capital needed to fund drilling programs. There is still a large amount of drilling slack to mop up before pricing power will improve, but the scope of bear market suggests share prices will turn well in advance of any fundamental improvement. We upgraded to neutral last October, and continue to look for an attractive point to shift to overweight. The ticker symbols for the stocks in this index are: BHI, CAM, DO, ESV, FTI, HAL, HP, NOV, SLB, RIG. bca.uses_in_2016_02_03_002_c1 bca.uses_in_2016_02_03_002_c1