Commodities & Energy Sector
Please see attached our <i>Third Quarter Strategy Outlook<i/> which discusses the major investment themes and views we see playing out for the rest of the year.
Brexit is putting our bearish short-term dollar view in question as global policy uncertainty has surged. Yet, investors are displaying elevated signs of risk aversion but the global economy still looks fine. This dissonance is likely to end with investors increasing risk taking, a bearish development for the counter-cyclical dollar. Favor commodity currencies over European ones.
Our strategic and tactical trades were up an average 24.6% in 2016Q2, led by strategic energy recommendations. Going forward, we continue to favor energy exposure over base and precious metals, ags and softs.
We view the "sweet spot" for market-balancing oil prices to be within a range of $50-$65/ barrel: Oil prices will be below/in the lower half of this range during 2016H2 and will average in the upper half of this range in 2017, perhaps exceeding the range in 2018. Without OPEC serving as an attentive "human regulator" of production, bouts of oversupply and undersupply will have to be managed through the drill bit (not the output valve), leading to increased price volatility beyond our "sweet spot" range. In this environment, quick-reacting U.S. shale producers and service companies are best positioned to benefit early in the up-cycle.
A number of divergences have emerged in global financial markets. These gaps are unsustainable. The recent improvement in Asian trade/manufacturing has been largely due to firming demand for electronics/semiconductors. Meanwhile, demand/output for industrial goods and basic materials - the areas leveraged to Chinese capital spending - remain weak. Fixed-income traders should bet on yield curve steepening in India: receive 1-year/pay 10-year swap rates.
For the month of June, the model performed in line with both global equities and the S&P 500. For the month of July, the model is increasing its risk exposure.
Global uncertainty is elevated, but markets know this. Brexit could prove extremely negative for the global economy if it prompts a questioning of the EU's integrity. The cyclical outlook for the pound remains poor, but a short-term opportunity to buy GBP/JPY has emerged. We still like the SEK and commodity currencies. The SNB will continue to intervene, but the peg is increasingly dangerous.
Post-Brexit uncertainty will continue for some time. But we were already cautiously positioned, and would not go any more defensive.
Even if commodity markets are not yet pricing a higher probability of fiscal stimulus following the U.K.'s Brexit vote, we believe they will begin doing so in very short order.
Equity and Treasury market positioning support the notion of a bounce in risk assets, possibly egged on by dollar weakness.