Jul 5, 2017 - CHIEF INVESTMENT OFFICE. The Weekly ... Gold fell 0.9% to end at $1,245.52 per ounce. ... oil investment are also factors, and in Russia.
CHIEF INVESTMENT OFFICE
The Weekly Letter JULY 5, 2017 Authors
Lower for longer oil: The surge, and potential surge, in global oil production capacity this year and next imply either more inventory accumulation or substantially bigger OPEC supply cuts and growing spare capacity. We believe both are consistent with loose market conditions and prices of at most $50 per barrel for the foreseeable future. For now, the market is dealing with excess supply that is difficult to sweep under the rug.
GWIM Chief Investment Office
Markets in Review: Last week through Thursday equities were mixed, with the S&P 500 down 0.7% and international equities, as measured by the MSCI EAFE Index, up 0.4%. Bond prices moved notably lower, with the 10-year Treasury yield up 13 basis points to 2.27% from 2.14% on Friday of the prior week. Commodities, as measured by the Bloomberg Commodity Index, rose 2.1%, helped by WTI crude’s 4.5% increase to $44.93 per barrel. Gold fell 0.9% to end at $1,245.52 per ounce.
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Looking Ahead: Next week is jobs report week in the U.S. In addition, a measure of activity in the service sector is expected. In Europe, the retail sales report is due, which may provide further confirmation on an economic recovery there.
Lower for longer oil OPEC’s agreement with 11 additional countries to withhold oil from the market in an attempt to engineer a decline in inventories helped sustain prices into the early part of this year. Many analysts extrapolated the improving price trend and predicted levels of more than $60 per barrel for 2017 and 2018. However, as demand surprised to the downside in the first quarter and supply started to surprise to the upside, these cuts started to look insufficient to shrink global inventories as desired. An upward revision to 2017 non-OPEC supply estimates, mainly in the U.S., coupled with a similar output gain in Libya since May have thrown cold water on hopes for a meaningful tightening of the oil market anytime soon. Nigeria has also started to show signs of greater stability and rising oil flows as a result of renewed government appeasement of Niger Delta militants. The surprise increase in the combined supply of these two countries has played a big role in depressing oil prices recently. If sustained, this gain would offset 25% of OPEC’s self-imposed cutback, watering down the cartel’s effort to support prices. What’s more, at 4.5 million barrels per day (mbd) in recent months, Iraqi supplies continue to defy expectations. The government targets a whopping 5 mbd production capacity this
Monthly Letter Value and the Style Cycle ISC Viewpoint A June Prune Not a Swoon
Exhibit 1: The U.S. oil rig count may have gotten ahead of itself Oil Rig Count Rig Count Estimated Based on Oil Prices 16 Weeks Before 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 2012
2013
2014
2015
2016
2017
Sources: Baker Hughes; U.S. Trust® Macro Research Team. Data as of June 22 2017. Past performance is no guarantee of future results.
year, which would be about two years sooner than assumed by the International Energy Agency in its 2017 mid-term oil report. U.S. crude production has surprised to the upside too. Shale oil production has shown its adaptability and responsiveness to the oil price environment. Plunges in rigs and production accompanied the collapse in prices from mid-2014 to early 2016, but they have retraced most of these declines as drilling surged over the past year. Gains have slowed, however, and drilling has gotten ahead of itself, in our view (see Exhibit 1),
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May Lose Value
given its past relationship to prices and the recent price declines. Going forward, it’s not a given that shale oil producers will cut production as rapidly on declining prices, since improving technology has been bringing down the price at which they can break even, keeping production potentially profitable at lower and lower price points.
rising standards of living in developing countries. For example, a small but rising coal-to-liquids supply is eroding the market share for crude. Growing use of biofuels and increasing electric vehicle penetration will replace some of the demand as well. So will ongoing efforts to release more Saudi Arabian oil for export by switching to natural gas for domestic power generation.
Against this backdrop, inventories appear likely to decline only about half as much as OPEC intended. While OPEC discipline may reduce inventories somewhat, it also works to substantially boost surplus capacity this year and next, still depressing expectations for prices.
Expanding fuel-efficiency standards in developing countries have an even greater potential to curtail growth in oil demand despite still-low per-capita consumption, great pent-up demand and relatively faster economic growth.
Supply resilience in the face of relatively low prices also reflects the large global investments made during the period of high oil prices, such as those in Brazil, Canada and Kazakhstan, which are still seen adding to supply through 2019. Moreover, the application of new technology to aging fields around the world precludes some previously anticipated production declines from materializing, especially in Brazil, where policies more favorable to oil investment are also factors, and in Russia. In sum, the surge, and potential surge, in global production capacity this year and next imply either more inventory accumulation or substantially bigger OPEC supply cuts and growing spare capacity, both consistent with loose market conditions and prices of at most $50 per barrel for the foreseeable future. The market is basically dealing with excess supply that is difficult to sweep under the rug.
Demand unlikely to come to the rescue U.S. and global demand growth showed more sensitivity to the drop in oil prices from 2014 to 2016 than generally had been anticipated, massively surprising to the upside in 2015 and 2016 with gains of 2.2% and 1.7%, respectively. The reverse has also been true. The 55% year-over-year price gain in the first quarter constrained oil consumption growth to a disappointing 1% from year-ago levels by keeping developed-world consumption flat and emerging-market demand subpar. Notwithstanding the weak start of the year, world oil demand is still seen up 1.3% on average this year and another 1.5% in 2018 as a result of faster global growth, softening oil prices and a strong rebound in the growth of Indian demand as the country recovers from its demonetization-related setbacks. While strengthening demand after the soft first quarter would be welcome, it would take even greater reacceleration than is currently estimated to mitigate the downside pressure on prices coming from higher-than-expected supply. The change in the mix of global fuel supply mitigates upside oil demand and price pressures coming from global growth and CIO REPORTS • The Weekly Letter
As a result, we maintain our assumption of about 1.2% to 1.3% growth in the average global demand for oil over the next four to five years. For a higher oil price trajectory, adjustments will likely have to take place on the supply side of the equation. The BofA Merrill Lynch (BofAML) Global Research commodities team points out that demand growth has undershot expectations in the first half of this year, removing support for prices just when they needed it most. The team also finds that global oil consumption growth tends to be lower at times of rising U.S. real interest rates and a flattening yield curve. Thus, the tighter monetary policy bias in both the U.S. and China against a backdrop of weaker economic data poses downside risks to oil demand and prices. As a counterweight, the sharp drop in prices so far this year should eventually spur demand. In sum, the OPEC agreement with only modestly rising demand suggest that oil inventories may decline slightly this year. Large production capacity gains in 2017 and 2018 greatly diminish the need for further additions after 2019, however, suggesting a relatively well-supplied oil market for longer than we had anticipated and at lower prices than we had expected just three months ago. With surplus capacity likely to start meeting some demand within two years, prices should eventually return to an upward trend. We expect a range of $40 to $50 per barrel to help the market digest the surge in supply in 2017 and 2018 and adjust expansion plans for 2019 and beyond. Portfolio Considerations: Energy was the best-performing S&P 500 sector last year but the biggest loser among them in the first half of 2017. We expect steady crude oil prices, recovering earnings and low valuations to improve returns as the year progresses. Key variables to watch include U.S. regulatory measures that could increase drilling on federal lands and boost domestic production, as well as any adjustments to OPEC policy that could further increase global supply. But our central case remains for a narrowing of the deficit in Energy sector returns as the year progresses.
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Rodrigo C. Serrano Vice President
Markets in Review Trailing Economic Releases
Equities
The
Bureau of Economic Analysis reported that its Personal Consumption Expenditure (PCE) Core Price Index increased 0.1% month-over-month (MoM) in May, while the prior month was revised downwards from 0.2% to 0.1%. May’s result was above the flat estimate from BofAML Global Research but in line with the consensus. The index rose by 1.4% yearover-year (YoY), below the Federal Reserve’s target rate of 2.0%.
The
University of Michigan released the final reading of its Consumer Sentiment Index for June. The result of 95.1 was above the preliminary reading and the estimate from BofAML Global Research of 94.5. While it’s still high, sentiment has moderated since hitting a multi-year peak in January, due in part to gridlock in Washington.
The
European Commission reported economic confidence for the region for June at 111.1, up from 109.2 and a recent multi-year peak of 109.7 in April. That was better than BofAML Global Research’s forecast of 108.8. Receding political risk and an improving economy have raised sentiment.
S&P 500 Sector Returns (as of last Thursday’s market close) S&P 500 Sector Total Returns (as of last Thursday's close)
DJIA NASDAQ S&P 500 S&P 400 Mid Cap Russell 2000 MSCI World MSCI EAFE MSCI Emerging Mkts
0.3% -0.5% -0.5% -0.7% -0.9% -1.3% -1.4% -1.4% -2.2% -2.8% -4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
Total Return in USD (%) WTD MTD YTD -0.5 1.4 9.0 -1.9 -0.8 14.8 -0.7 0.5 9.2 0.1 1.5 5.8 0.2 3.5 5.1 -0.2 0.5 10.8 0.4 0.5 14.6 0.4 1.3 18.8
Fixed Income Yield (%) ML US Broad Market ML 10-Year US Treasury ML US Muni Master ML US IG Corp Master ML US HY Corp Master
2.48 2.27 2.31 3.18 5.65
Total Return in USD (%) WTD MTD YTD -0.4 0.1 2.5 -0.9 -0.3 2.6 -0.5 -0.2 3.4 -0.4 0.4 4.0 0.3 0.1 4.9
Commodities & Currencies
Bloomberg Commodity WTI Crude $/Barrel1 Gold Spot $/Ounce1
Level 165.1 44.9 1,245.5
Level EUR/USD USD/JPY
Current 1.14 112.18
3.4%
Financials Energy Consumer Discretionary Materials Industrials Real Estate Consumer Staples Telecom Healthcare Utilities Information Technology
Level 21,287.0 6,144.4 2,419.7 1,744.0 1,416.2 1,919.6 1,895.8 1,014.0
Total Return in USD (%) WTD MTD YTD 2.1 -1.7 -6.7 4.5 -7.0 -16.4 -0.9 -1.8 8.1 Prior Prior 2016 Week End Month End Year End 1.12 1.12 1.05 111.28 110.78 116.96
Source: Bloomberg.1 Spot price returns. All data as of last Thursday’s close. Past performance is no guarantee of future results.
Looking Ahead Upcoming Economic Releases On
Thursday, the Institute for Supply Management will release an indicator designed to measure the degree of growth or contraction in the service sector. The Purchasing Managers Index for June is expected to rise marginally to 57.0 from 56.9, according to BofAML Global Research, indicating continued brisk growth.
On
Friday, the U.S. Bureau of Labor Statistics releases its payroll report for June. BofAML Global Research estimates that 185,000 net jobs were created, that wages increased by 0.3% MoM, and that the unemployment rate remained steady at 4.3%.
In
the Eurozone on Wednesday, Eurostat will report growth in retail sales for the bloc. BofAML Global Research expects a YoY increase of 2.2%, moderating from 2.5% in the month prior. A betterthan-expected reading would further confirm improving economic conditions and raise expectations of further announcements of plans for the European Central Bank to reduce monetary stimulus.
BofA Merrill Lynch Global Research Key Year-End Forecasts S&P 500 Outlook Target
2017 E 2,450
EPS
$129.00
Real Gross Domestic Product
2017 E
Global
3.5%
U.S.
2.1%
Euro Area
1.9%
Emerging Markets
4.6%
U.S. Interest Rates
2017 E
Fed Funds (eop)
1.38%
10-Year T-Note (eop)
2.85%
Commodities
2017 E
Gold ($/oz-period average)
$1,276
WTI Crude Oil ($/bbl-eop)
$47.00
All data as of last Thursday’s close. CIO REPORTS • The Weekly Letter
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CHIEF INVESTMENT OFFICE Christopher Hyzy
Chief Investment Officer Bank of America Global Wealth & Investment Management
Mary Ann Bartels
Karin Kimbrough
Niladri Mukherjee
Head of Merrill Lynch Wealth Management Portfolio Strategy
Head of Investment Strategy Merrill Lynch Wealth Management
Director of Portfolio Strategy, Private Banking & Investment Group (PBIG) and International
Nicholas Giorgi
Emmanuel D. Hatzakis
Marci McGregor
Rodrigo C. Serrano
John Veit
Vice President
Director
Director
Vice President
Director
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