Commodities & Energy Sector

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.

Special Report

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.

It is highly unusual for equities to enter a bear market without the economy going into recession. Since we see the risk of recession as low, we recommend a neutral allocation between bonds and equities.

Any recovery in risk assets and selloff in safe havens is unlikely to extend into the cyclical horizon.

Last month, the model outperformed both global and U.S. equities in local-currency and U.S.-dollar terms. For February, the model is aggressively increasing its risk exposure and has included a bet on commodities for the first time since 2012. For equities, the largest overweight remains Europe, but EM and Canada enjoyed significant upgrades. For bonds, the model favors the European periphery.

The Fed will upset the rebalancing of oil markets if it misreads the current sell-off as weakness in oil demand.

The U.S. corporate re-leveraging cycle is far more advanced than is widely believed. Corporate health looks only mildly better excluding the troubled energy and materials sectors. Mushrooming leverage ratios are not restricted to junk issuers either.