- A recent drop in energy-related assets appears overdone given our outlook for oil prices, creating opportunities.
- Policy uncertainty led to modest declines in developed market stocks. The yen hit a four-month high versus the U.S. dollar.
- The UK is set to formally begin the Brexit process this week by triggering Article 50 of the Treaty of Lisbon.
1. Buying the oil dip
A recent drop in energy-related assets looks to be overdone. We believe this creates opportunities in selected energy equities and credit – even as we see oil prices trading mostly sideways in the near term.
Chart of the week
World energy equities' relative performance and crude oil prices, 2014-2017
Sources: BlackRock Investment Institute and Thomson Reuters, March 2017.
Notes: The relative performance of energy equities is based on the MSCI World Energy Index total return divided by the MSCI World Index total return, rebased to 100 at the start of 2014. The price of oil is based on the benchmark front-month Brent crude oil futures contract price.
Oil prices fell this month after trading in a tight range in early 2017. Concerns about oversupply led to the unwinding of record-levels of speculative bets on higher crude prices. Energy stocks, however, appear to be pricing in too much pessimism. See the increasing performance gap between oil and global energy stocks above.
In a range-bound world
Demand and supply conditions supported oil prices earlier this year. Speculative trades in futures markets also contributed to crude’s rise on expectations the Organisation of Petroleum Exporting Countries (OPEC) and non-OPEC countries would implement agreed-upon production cuts. Nervousness about record levels of such positions, rising U.S. supply and growing doubts about production-cut compliance sparked oil’s recent price drop. Further unwinding could pressure prices further in the short term.
Oil prices are hard to predict, as production cuts hinge on an uncertain political environment. We see oil trading mostly sideways over the next few months. OPEC members have shown discipline in cutting oil production, and U.S. inventory growth should soon stabilise as oil refiners increase purchases. Global demand is also likely to rise amid reflation.
Energy stocks appear to reflect a more bearish price outlook. This creates opportunities. We like U.S. shale companies, amid cost cuts, improving technologies and prospects for looser regulation. We also see value in the diversification potential offered by integrated-energy firms, including relatively cheap European oil majors. High yield energy bonds offer slightly better value after a recent sell-off. We prefer the debt of exploration companies due to attractive yields and balance sheet discipline.
- Developed market stocks posted modest declines on U.S. fiscal policy uncertainty. A weaker U.S. dollar sent the safe-haven yen to a four-month high. U.S. Republican leaders pulled their health-care bill.
- Cash conditions in China’s interbank market tightened following People’s Bank of China (PBoC) moves to raise short-term rates. The PBoC injected funds to calm the market.
- The European Central Bank’s final long-term financing operation attracted unexpectedly strong take up. European PMI data came in strong.
|March 29||UK scheduled to trigger Article 50 of the Treaty of Lisbon|
|March 31||China PMIs; eurozone inflation; Chicago PMI|
The triggering of Article 50 of the Treaty of Lisbon is the first step required to formally begin the long Brexit process of pulling the UK out of the European Union. So far, the UK economy and financial markets have stood fast but heightened uncertainty ahead makes for a cloudier outlook.
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