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.
World energy equities' relative performance and crude oil prices, 2014-2017
Sources: BlackRock Investment Institute, MSCI 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.
Demand and supply conditions supported oil prices earlier this year. Speculative trades in futures markets also contributed to crude’s rise on expectations the Organization 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 stabilize 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.
|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.
Weekly and 12-month performance of selected assets
|Equities||Week||YTD||12 Months||Div. Yield|
|U.S. Large Caps||-1.4%||4.7%||15.1%||2.1%|
|U.S. Small Caps||-2.6%||0.1%||27.3%||1.3%|
|U.S. Investment Grade||0.7%||1.1%||4.0%||3.3%|
|U.S. High Yield||-0.2%||1.8%||15.8%||6.1%|
|Emerging Market $ Bonds||0.7%||3.9%||9.7%||5.4%|
|Brent Crude Oil||-1.9%||-10.6%||25.6%||$50.80|
Source: Bloomberg. As of March 24, 2017.
Notes: Weekly data through Thursday. Equity and bond performance are measured in total index returns in U.S. dollars. U.S. large caps are represented by the S&P 500 Index; U.S. small caps are represented by the Russell 2000 Index; Non-U.S. world equity by the MSCI ACWI ex U.S.; non-U.S. developed equity by the MSCI EAFE Index; Japan, Emerging and Asia ex-Japan by their respective MSCI Indexes; U.S. Treasuries by the Bloomberg Barclays U.S. Treasury Index; U.S. TIPS by the U.S. Treasury Inflation Notes Total Return Index; U.S. investment grade by the Bloomberg Barclays U.S. Corporate Index; U.S. high yield by the Bloomberg Barclays U.S. Corporate High Yield 2% Issuer Capped Index; U.S. municipals by the Bloomberg Barclays Municipal Bond Index; non-U.S. developed bonds by the Bloomberg Barclays Global Aggregate ex USD; and emerging market $ bonds by the JP Morgan EMBI Global Diversified Index. Brent crude oil prices are in U.S. dollars per barrel, gold prices are in U.S. dollar per troy ounce and copper prices are in U.S. dollar per metric ton. The Euro/USD level is represented by U.S. dollar per euro, USD/JPY by yen per U.S. dollar and Pound/USD by U.S. dollar per pound. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index. Past performance is not indicative of future results.