Please note the views expressed in this bulletin are those of the author and do not necessarily reflect AMP Capital’s house view.
Theme 1: Oil price drop
The shale oil revolution remains an important theme for the US, oil and geopolitics.
One of the lesser followed developments in the markets has been the drop in oil prices. Oil has fallen about $10 to the low $50s from its post-crash-rebound-range around $60. Part of this stems from the potential for an Iran nuclear deal (the other big geopolitical negotiation that is going on right now). But again, it’s also the ongoing impact of the shale factor.
The plunge in oil prices did not kill shale, but it certainly put the pressure on. It put the pressure on for operations to become more efficient; it also put the pressure on to find ways to capture more value, such as exporting the lower grade version of oil allowed to be exported under a loophole in the oil ban.
It’s worth highlighting the point that the US still has a ban on crude oil exports (with some exceptions for certain grades). It put this ban in place during the 1970s oil shortage. You might ask why do they still have this ban and that’s a good question. It’s one that many are beginning to ask, and according to our sources we may see the ban overturned as early as next year. If this ban is overturned it will likely trigger an echo-boom in shale oil.
The shale oil revolution just goes to show the impact of technology in smashing previously held assumptions (i.e. in the past there was concern about peak oil – but in the end high oil prices led to technological breakthroughs that opened up previously uneconomic oil reserves).
Theme in pictures
Source: AMP Capital, US EIA
Theme 2: Spain and Italy
Spain and Italy are back to growth…..this is one aspect that makes the Eurozone economic recovery more robust!
It’s worth highlighting again the state of economic conditions in Spain and, in particular, Italy. These countries have the fourth and third largest economies in the Eurozone; and more importantly for Europe, they have gone from being a drag on growth to a positive contributor to growth. This is because progress has been made on reforms and the benefits of easier financial conditions have begun to flow through.
It also highlights the point that the major peripheral countries are in a very different position now as to when the previous sovereign debt crisis worries were at their heights. This is one reason we are reasonably optimistic that the Eurozone economy can withstand the negative confidence impact from the Greece-related uncertainty and even a potential Grexit scenario.
Theme in pictures
Source: AMP Capital, Thomson/Reuters Datastream.
Theme 3: Gains in grains
There’s been a short-squeeze in grains resulting in an upside breakout…..there may be further to go!
I mentioned this in a previous edition when the speculative positioning across corn, wheat, and soybeans was extremely short. Since then there has been a bit of a short-squeeze and prices have spiked. Looking at past episodes, spikes in grain prices can be quite large, so while the easy gains from the clean-out of positioning have probably been had there may still be some upside yet.
With regards to technicals, the spike in grain prices has seen an upside breakout through the 200 day moving average, which is often a good sign. The other point is that the El Niño weather conditions may cause more adverse weather events – which is a key variable in grain prices. The other nice thing is that grain is relatively independent of other financial assets so it is a valid diversifier.
Theme in pictures
Source: AMP Capital, Thomson/Reuters Datastream
Theme 4: I hearby name the recent sell-off in bonds the ‘Reflation reaction’
The reflation reaction hit bonds and REITs equally hard, but now sentiment is at extreme pessimism levels
Recall bonds rallied sharply on the back of the oil crash as the deflation scare hit extremes. Subsequently, bonds sold off aggressively from very overvalued levels. But the focus of this theme is actually on the fallout - in particular, US REITs. US REITs have actually been punished to a similar extent as during the ‘taper tantrum’ of 2013 (note with benefit, that when the Fed actually began to taper quantitative easing it marked a turning point in the opposite direction as originally feared).
So this leaves an open question as to whether the reflation reaction fears will actually be justified if or when the reflation (return of inflation) does eventually show its face. In any case, sentiment on US REITs is very downtrodden and there have been heavy outflows from the US REIT ETFs. To be fair, you would probably see this kind of activity during a trend change, but certainly in the past five years during the search for yield regime it has presented a reliable tactical buying signal. Ultimately, REITS are expected to beat bonds in the long run due to growth in income (rent) through time; so to that end the economy is also a key variable… REITs will generally only really get completely smashed during a recession (rather than a rise in bond yields – which would probably be accompanied by higher growth and improving fundamentals).
Theme in pictures
Source: AMP Capital, Bloomberg