Energy

The remarkable admission by OPEC's secretary-general, Salem el-Badri, earlier this week that with "any increase in (oil's) price, shale will come immediately and cover any reduction" in output only hints at the larger impact of light-tight-oil (LTO) going forward.

The sheer scale of underperformance leaves the oilfield services group vulnerable to violent bounces, especially in view of the recent stabilization in oil prices as well as an agreement between several OPEC members and Russia to freeze output at current levels. Is it time to buy? While oil supply will eventually be reined in, demand growth is still up for debate. The global economy is struggling to maintain a decent rate of growth. Importantly, energy service stocks have an abysmal track record during recessions and/or when the ISM manufacturing index is below the boom/bust line. In other words, the group is a late-cycle performer, not an end-of-cycle performer. While the U.S. is not technically in recession, the odds of one are rising steadily as credit conditions tighten. Even then, upside potential may be more muted than in previous cycles. Fracking technology and producer's flexibility to quickly ramp up output suggests that the large boom/bust cycles in supply will not hold true going forward. The natural gas market is a prime example. The implication for oilfield services investors is that peak earnings could be much lower than in the past, which will reduce investor willingness to speculate on upcycles and warrant a higher risk premium. We are sticking with a neutral weighting, despite the likelihood of periodic oversold spikes. The ticker symbols for the stocks in this index are: SLB, HAL, BHI, CAM, NOV, FTI, HP, RIG, ESV, DO. bca.uses_in_2016_02_23_001_c1 bca.uses_in_2016_02_23_001_c1

The deeply negative momentum in oil prices is fading, setting up the possibility of a counter-trend rebound in global inflation expectations and perhaps even the beaten-up U.S. High-Yield bond market.

Lean against rally attempts until leading profit indicators improve. The conditions for a tradable oilfield services rebound remain elusive. Capital markets may bounce, but we would sell on strength.

The agreement to freeze oil production should reduce tail risks, even if it does not improve overall corporate sector health and profits.

While the oil market looked right through the Russian-Saudi production-freeze announcement earlier this week, we believe these states may be attempting to put lipstick on the proverbial pig, to provide a plausible narrative to explain the physical reality of lower oil production in a sub-$30/bbl world.

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.

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.