Tuesday, March 7, 2017

Tuesday, March 7, Morning Global Market Roundup: Banks, Earnings, German Data Keep European Stocks In The Red

By Jamie McGeever
Reuters
March 7, 2017

European stocks fell for a third consecutive day on Tuesday, once again dragged down by financials as shares in Deutsche Bank slid on deepening concern about its health after its $8.5 billion cash call.

A batch of weak corporate earnings reports and the biggest fall in German industrial orders since the depths of the global financial crisis also disappointed investors, setting the tone for a lackluster session in Europe.

Europe's leading index of the top 300 shares fell as much as 0.5 percent .FTEU3, with the region's banking index down as much as 0.7 percent. By 0945 GMT the FTSEuroFirst had clawed back ground to trade only slightly lower on the day, and financials were down 0.3 percent.

Deutsche (DBKGn.DE) shares fell almost 3 percent to a fresh 2017 low. They have lost more than 10 percent in the last few days since the bank said it would tap investors for $8.5 billion.

"Weak German industrial orders suggests it's not a one-way ticket in Europe – there's been a lot of bullishness around European equities lately but maybe this is a sign it's not all positive. Deutsche Bank is not helping either," said Neil Wilson, senior market analyst at ETX Capital.

British temporary power provider Aggreko (AGGK.L) slumped almost 11 percent and French retailer Casino Guichard (CASP.PA) fell 5 percent after publishing their results.

German industrial orders slumped 7.4 percent in January, the biggest fall since January 2009 and nearly three times as steep as the 2.5 percent fall expected by economists.

U.S. futures pointed to a slightly lower open on Wall Street ESc1 DJc1, cooling from last week's record highs as investors prepare for an all-but-certain interest rate hike next week.

MSCI's broadest index of Asia-Pacific shares outside Japan .MIAPJ0000PUS rose 0.4 percent, and Japan's Nikkei .N225 closed down 0.2 percent.

Dollar Up

In currencies, the dollar inched higher against a basket of trade-weighted peers. The dollar index rose 0.1 percent to 101.73 .DXY, mirroring Monday's slender gain.

A rate hike from the Federal Reserve next week is virtually fully priced into financial markets, so the dollar and U.S. bond yields might be vulnerable to a correction lower.

But investors saw enough room to push the greenback and yields higher on Tuesday, lifting the 10-year yield for the fifth day in a row back above 2.50 percent US10YT=RR and the two-year yield up a basis point to 1.32 percent US2YT=RR.

Sterling was the biggest mover on major FX markets, falling nearly a third of one percent against the dollar to a seven-week low of $1.2202 GBP=.

Britain's House of Lords will on Tuesday try to force the government to give lawmakers a greater say over the terms of Britain's exit from the European Union and final approval of an eventual deal with the block.

Analysts at Morgan Stanley said on Tuesday they expect the pound to snap back as high as $1.45 by the end of next year.

"Sterling looks increasingly cheap in a historical context and our FX strategists (have) recently turned more bullish on the currency, targeting $1.28 for year end and $1.45 by the end of 2018," they wrote in a note on Tuesday.

The euro was steady at $1.0575 EUR= and the dollar was flat against the yen at 113.90 yen JPY=.

In commodities, U.S. oil CLc1 rose 0.3 percent to $53.55 a barrel, following Monday's 0.2 percent drop, and Brent crude also rose 0.3 percent to $56.17 LCOc1.

Gold slipped 0.1 percent to $1,225 an ounce XAU=.


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Oil Prices Entrenched In Tight Range; Eyes On Data

By Sabina Zawadzki 
Reuters
March 7, 2017

Oil prices were little changed on Tuesday, trading in a tight range as rising U.S. shale output offset OPEC crude production cuts, with investors seeking clearer direction from upcoming inventory data and comments from senior oil officials.

Brent crude LCOc1 was down 3 cents at $55.98 a barrel as of 1020 GMT. U.S. West Texas Intermediate crude CLc1 was flat at $53.20. Both benchmarks have traded in negative and positive territory since the start of Asia trading.

Oil prices have been entrenched in a $3 band since February, failing to take off after OPEC implemented, to a surprisingly high degree, the first cut in production in eight years.

Capping any upsurge has been an inevitable rise in U.S. shale oil drilling after WTI rose firmly above the $50 a barrel level in December following OPEC's sealing of the deal, which also included several non-OPEC producers such as Russia.

"Brent is pivoting around $56, with focus on last week's low at $55 and resistance at $57.20," said Ole Hansen, Saxo Bank's head of commodity strategy.

"Market-wise, we have seen open interest on Brent fall to a six-week low as non-performing or even loss making longs have begun to reduce exposure," he added.

Fund managers doubled their net long positions in Brent, WTI and options to 951 million barrels between the start of November and Feb. 21, betting OPEC's high compliance with the cut agreement would push up prices.

But with Russia's lackluster participation in the cuts, rising shale output and signs that OPEC countries increased their crude exports in February after a January reduction, that bullish sentiment has wavered.

The International Energy Agency (IEA) forecast U.S. shale output to grow at about 1.4 million barrels per day by 2022, saying it would climb even if prices remain around $60 a barrel. A rise to $80 a barrel could precipitate shale growth of 3 million bpd by 2022, it said.

Analysts said markets may take cue from data this week including U.S. oil inventory stocks as recorded by industry group API on Tuesday and the U.S. Energy Information Administration on Wednesday as well as import-export data from China on also Wednesday.

U.S. oil inventories are expected to rise for the ninth consecutive week to hit a record high, according to a Reuters poll.

Major oil company executives, energy ministers, including from Saudi Arabia and Russia, and other top officials such as the head of OPEC are meeting in Houston this week for CERAWeek and observers are keen for any comments that may indicate whether OPEC would extend its output reduction deal.

Russia and Iraq said it was too early to discuss that issue but OPEC's secretary general as well as Saudi officials are expected to speak later on Tuesday.


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Banks Come In From The Cold For Hedge Funds

By Maiya Keidan and Svea Herbst-Bayliss
Reuters
March 7, 2017

Bank stocks are back in vogue for hedge funds, which have shunned the industry over the past seven years due to a squeeze on banks' profitability from low interest rates and because of their opaque balance sheets.

The election of U.S. President Donald Trump has already tempted some hedge funds back into bank stocks to raise their bets on deregulation and interest rate rises in the United States, which could help banks to earn higher returns on deposits.

"I think people are overweighting," Hilmi Unver, partner at hedge fund investor Notz Stucki Group, said. "Financials should benefit from interest rates going up." He also said Trump was pro deregulation, which would benefit U.S. banks.

Banks made up five of the 50 stocks most commonly in the top ten holdings of hedge funds at the start of 2017, the largest portion since 2013, data from Goldman Sachs showed.

Among the top five stocks were Bank of America Corp (BAC.N), JPMorgan Chase & Co (JPM.N), Wells Fargo & Co (WFC.N), Citigroup (C.N) and Citizens Financial Group (CFG.N).

Globally, institutional investor appetite for hedge funds buying bank stocks has risen in January to its highest level since 1999, estimated at 16.4 percent, up from 13.9 percent in December 2016, according to preliminary data from industry tracker Blue Lion Research.

Many managers favor U.S. banks stocks, but some hedge funds are also trickling into European banks even though some of these lenders are still dealing with fallout from the 2008 financial crisis and now face uncertainty from upcoming elections.

"European banks trade at almost half the valuation of U.S. banks and I think the political risk is overstated ... a lot of people are on the sidelines," said one London-based hedge fund manager who started adding European banks to his portfolio in January. "The big money will be made by buying these things now."

“One of our biggest long positions is Credit Suisse," Lars Franstedt, chief investment officer and partner at $150 million Madrague Capital Partners, said. "We believe that it’s one of the best ways to play long in the financial industry."

Said Haidar, president and chief executive officer at $313 million Haidar Capital Management, which is long banks globally, also said European banks looked cheap.

Low and even negative interest rates in Europe have made it difficult for banks to generate profits on deposits, depressing their shares, which has kept many hedge funds away.

But banks' profits could improve now interest rates are on the rise in the United States and ultimately could rise in Europe too.

"In Europe, where banks trade at steep discounts to book (value), steeper curves, the coming end to quantitative easing followed by rate hikes in late 2018 or early 2019 should bolster results," Haidar said.

Wellington Management’s hedge fund Bay Pond Partners, a fund which focuses on the financial sector in general, has benefited from a strong move in bank stocks.

After losing 7.1 percent in 2016, the fund gained 6.4 percent in January, several people familiar with the fund’s performance said.

Representatives for the fund were not immediately available to comment.

U.S. hedge fund manager Dan Loeb shifted his focus to banks, he wrote in an investor letter on Wednesday, with the sector now making up 11.8 percent of his $15 billion fund, up from 4.4 percent on Nov. 8.

Before the financial crisis, many hedge funds reaped big rewards from a bull market in banks between 2005 and 2007. They then took short positions on banks between mid-2007 and 2009, betting on falling share prices. During this period, for example, Bank of America shares lost almost 75 percent of their value, according to Thomson Reuters data.

But after 2009, most funds stepped back from banks because of pressure on deposits from low interest rates. Some even shut up shop completely. Lansdowne Partners, one of London's oldest hedge funds, closed its financials fund last year, which had lost 18.7 percent in the first 40 days of 2016.


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OECD: Economic Nationalism, Volatility Threatens Modest Recovery

By Leigh Thomas
Reuters
March 7, 2017

A modest recovery underway in the global economy is at risk from economic nationalism and diverging central bank policies, the OECD said on Tuesday as it forecast only a slight pick-up in growth.

The Paris-based Organisation for Economic Cooperation and Development estimated global economic growth would run at 3.3 percent this year before reaching 3.6 percent in 2018, unchanged from its last estimates in November.

OECD chief economist Catherine Mann said that higher interest rates in the United States could unleash damaging volatility on financial markets for some borrowers while potentially pushing the dollar higher.

"The economic nationalism is a much bigger wildcard because we don't know how the language translates into policy at this point," Mann told Reuters as the OECD updated its outlook for major economies.

U.S. President Donald Trump's campaign promises last year to put "America first" in trade, and his calls for tariffs on imports from China and Mexico, caused consternation among the United States' major trade partners.

Though Washington was not alone in using nationalistic rhetoric, Mann said the OECD had estimated that a 10 percent increase in U.S. import costs would percolate through the economy and ultimately lift export costs by 15 percent.

Volatile Times

The OECD said that with only a modest recovery in view in most countries, financial markets were becoming disconnected from economic reality as consumer spending and business investment remained weak.

With the U.S. Federal Reserve widely expected to steadily hike interest rates for some time, the OECD said that exchange rate swings could be expected.

That could put at risk emerging market borrowers who binged on cheap dollar loans in recent years, especially in countries with excessive levels of private sector debt, like China.

Updating its last forecasts for major economies, the OECD estimated the U.S. economy would grow 2.4 percent this year as domestic demand firms, up from 2.3 percent in its last forecasts from November.

U.S. growth was seen reaching 2.8 percent in 2018, down from a November estimate of 3.0 percent, as higher government spending helped offset the impact of rising interest rates and a stronger dollar.

With monetary policy relaxed and some fiscal policy easing in the euro zone, growth was seen steady this and next year at 1.6 percent, with the 2017 forecast unchanged and the 2018 forecast trimmed from 1.7 percent in November.

As rising inflation hits British consumers and businesses put investment on hold over Brexit, British growth was seen slowing from 1.6 percent this year to 1.0 percent in 2018. The OECD had forecast 2017 growth of 1.2 percent in November and its 2018 forecast was unchanged.

In Japan, fiscal easing was seen underpinning growth of 1.2 percent though the rate was seen falling back to 0.8 percent in 2018. In November, the OECD had forecast growth of 1.0 percent this year and its estimate for 2018 was unchanged.


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U.S. Republicans Unveil Plan To Dismantle Obamacare, Critics Pounce

By Susan Cornwell and Yasmeen Abutaleb
Reuters
March 7, 2017

Long-awaited legislation to dismantle Obamacare was unwrapped on Monday by U.S. Republicans, who called for ending health insurance mandates and rolling back extra healthcare funding for the poor in a package that drew immediate fire from Democrats.

In a battle waged since the 2010 passage of the Affordable Care Act, Democratic President Barack Obama's signature domestic policy achievement, Republicans including President Donald Trump have long vowed to repeal and replace the law. But they failed for years to coalesce around an alternative.

With a proposal now on the table, the fate of the plan is uncertain even with Republican majorities in both chambers. Also unclear is where Trump stands on many of the details.

"Today marks an important step toward restoring healthcare choices and affordability back to the American people," the White House said in a statement, adding Trump looked forward to working with Congress on replacing Obamacare.

Republicans condemn Obamacare as government overreach, and Trump has called it a "disaster."

Critics complained about the penalty the law charged those who refused to buy insurance. The Republican proposal would repeal that penalty immediately.

Congressional Democrats denounced the Republican plan, saying it would hurt Americans by requiring them to pay more for healthcare, to the benefit of insurers.

Obamacare is popular in many states, even some controlled by Republicans. It has brought health insurance coverage to about 20 million previously uninsured Americans, although premium increases have angered some.

About half those people gained coverage through an expansion of the Medicaid program for the poor. The Republican proposal would end the Medicaid expansion on Jan. 1, 2020, and cap Medicaid funding after that date.

Just before the plan was unveiled, four moderate Senate Republicans jointly expressed concern that an earlier draft would not adequately protect those who got coverage under Medicaid, raising doubts about the legislation's future in the Senate.

Several Senate and House conservatives have already expressed doubt about another aspect of the plan, the offering of tax credits for the purchase of health insurance. The proposal seeks to encourage people to buy insurance with the age-based credits, which would be capped at upper-income levels.

The legislation would abolish the current income-based subsidies for purchasing insurance under Obamacare.

The proposal would protect two of the most popular provisions of Obamacare. It would prohibit insurers from denying coverage or charging more to those with pre-existing conditions, and it would allow adults up to age 26 to remain on their parents' health plans. Trump has long supported by both ideas.

The measure would also provide states with $100 billion to create programs for patient populations, possibly including high-risk pools to provide insurance to the sickest patients.

'Frankly Not Enough'


The overall cost of the Republican plan, a key issue in a time of high federal deficits, was not yet known, Republican aides said. Two House committees will next review the plan.

Craig Garthwaite of Northwestern University said the proposed tax credits, which would range from $2,000 to $4,000, were "frankly not enough for a low-income person to afford insurance."

Republicans said the legislation would give Americans the flexibility to make their own healthcare choices, free of Obamacare's mandate that people buy health insurance and the law's taxes, including a surtax on investment income earned by upper-income Americans.

"Our legislation transfers power from Washington back to the American people," House Ways and Means Chairman Kevin Brady said in a statement.

Senate Democratic Leader Chuck Schumer said in a statement, however, that "Trumpcare doesn’t replace the Affordable Care Act, it forces millions of Americans to pay more for less care."

"Paying for all this is going to be a big issue," said Joe Antos of the American Enterprise Institute think tank.

"It's possible that CBO (the Congressional Budget Office) is going to say the Medicaid reductions aren't enough to offset the revenue losses from repealing all the taxes."

A hospital group voiced disappointment that lawmakers were willing to consider the measure without knowing how much it cost or how it might affect healthcare coverage.

The proposal "could place a heavy burden on the safety net by reducing federal support for Medicaid expansion over time and imposing per-capita caps on the program," said America's Essential Hospitals, which represents hospitals that provide care to low-income and uninsured individuals.


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Autos Bosses Focus On Technology, Play Down PSA-Opel Impact

By Agnieszka Flak and Andreas Cremer
Reuters
March 7, 2017

The auto industry is facing seismic changes with the rise of electric vehicles, automated driving and car sharing, and adapting to these will eclipse even big mergers such as PSA's purchase of Opel, executives at the Geneva auto show said.

Peugeot maker PSA Group (PEUP.PA) on Monday agreed to buy loss-making Opel from General Motors (GM.N), creating Europe's second-biggest carmaker behind Volkswagen (VOWG_p.DE) and sparking speculation of more consolidation.

However, some executives gathering in Geneva said the deal was unlikely to change the industry landscape on its own, with new competitors in Silicon Valley and China and changing consumer habits set to have a much bigger impact.

"We are really in a transitionary phase for the industry. There are new competitors on the horizon like Tesla or Chinese ventures," Herbert Diess, the head of Volkswagen's (VW) main passenger car division, told reporters.

"My feeling is that the industry as a whole and brand positioning will change in the next 10 or 15 years and that comes in addition to traditional consolidation in the industry," he said, adding he did not expect a wave of Opel-style deals.

Volkswagen (VW) is investing billions of euros in electric vehicles, automated driving and new mobility services, in part as it tries to recover from an emissions test cheating scandal on diesel engines which has hit demand for diesel vehicles.

The company is unveiling a fully self-driving concept car at the Geneva show.

Karl Schlicht, head of European sales at Japan's Toyota Motor Corp (7203.T), also played down the impact of the PSA-Opel deal, which brings together two carmakers with heavy focuses on diesel and low-margin fleet vehicles, respectively.

"We ran a counter strategy in Europe which may not look as successful for some past years because our volumes were a bit lower, but in terms of where we want to end up, it’s turning out to be a good strategy," he said, referring to Toyota's investments in hybrid vehicles.

The company forecasts its European sales will rise 5 percent this year, compared with an industry expected to grow 1 percent.

Some industry analysts also say an enlarged PSA could actually ease the pressure on rivals if CEO Carlos Tavares uses similar methods to turn around Opel that worked at PSA.

Exane's Dominic O'Brien, for example, sees Opel "adopting more disciplined pricing strategies akin to PSA’s current model."

In the three years since Tavares took the helm at PSA, its three existing brands - Peugeot, Citroen and DS - have significantly increased pricing relative to benchmarked peers, sometimes at the expense of sales.

A similar approach at Opel, which has been among the region's most aggressive discounters, could give the entire European mass-market car industry some breathing space.

Stefan Bratzel of the Center of Automotive Management in Bergisch Gladbach, Germany, said it was the potential improvement in profitability at PSA-Opel that posed a bigger challenge to rivals than its sheer size.

"There is no survival of the fattest," he said. "Just because you're big, you do not win the game."


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GM Will Lay Off 1,100 In Michigan After Domestic Production Shift

By David Shepardson
Reuters
March 7, 2017

General Motors Co (GM.N) said on Monday it will lay off 1,100 workers in May at its Lansing Delta Township assembly plant in Michigan as it shifts production of a vehicle to Tennessee.

The largest U.S. automaker last year added 800 jobs at its Spring Hill, Tennessee plant to build a new version of the GMC Acadia SUV. The Lansing plant will continue building the Buick Enclave and Chevrolet Traverse after it retools for a month, GM spokesman Tom Wickham said in an emailed statement.

GM has announced other U.S. factory cuts even after it said in January it would invest another $1 billion in U.S. factories.

U.S. President Donald Trump has urged GM and other automakers to build more cars in the country as part of his pledge to boost U.S. manufacturing jobs and discourage the industry from investing in Mexico.

GM has said the $1 billion investment would allow it to create or retain 1,500 U.S. jobs, but has not specified what jobs are impacted.

GM has also said it will begin work on bringing axle production for its next generation of full-size pickup trucks, including work previously done in Mexico, to operations in Michigan, creating 450 U.S. jobs. The part was previously built by American Axle & Manufacturing Holdings Inc.

GM said in November it would cut about 2,000 jobs when it ended the third shift at its Lordstown, Ohio, and Lansing Grand River plants in January. In December, it said it planned to cancel the second shift and cut nearly 1,300 jobs from its Detroit-Hamtramck assembly plant in March.

Those job cuts were sparked by lower demand for cars as Americans buy more SUVs and other larger vehicles.

Trump has repeatedly praised GM's January investment announcement.

GM "committed to invest billions of dollars in its American manufacturing operation, keeping many jobs here that were going to leave. And if I didn't get elected, believe me, they would have left," Trump said at a news conference in February.

GM has been adding a significant number of U.S. jobs in recent years. It had 105,000 U.S. employees at the end of 2016, up from 97,000 at the end of 2015, according to a company filing in February. GM on Monday declined to provide its current U.S. employment figure.

In a deal announced on Monday, GM will sell its European operations to France's PSA Group in a move that doubles down on the U.S. company's aim of being less global but more profitable.


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Wall Street Futures Point To Lower Open; Trump's Economic Policies In Focus

By Sam Meredith
CNBC
March 7, 2017

U.S. stock index futures pointed to a lower open on Tuesday morning amidst growing concerns over U.S. President Donald Trump's ability to implement economic policies.

The long-awaited legislation to repeal and replace Obamacare was unveiled on Monday by U.S. Republicans although it was greeted with immediate criticism from the Democrats.

On the data front, Tuesday will see trade deficit and consumer credit for January released at 8.30 a.m ET and 3.00 p.m ET respectively.

On the earnings front, Brown-Forman, Dick's Sporting Goods and Momo are among the companies scheduled to report before the bell. H&R Block, Aerovironment and Urban Outfitters are all due to report after the market close.

Market expectations for a U.S. interest rate hike were at 86.4 percent Monday, according to the CME Group's FedWatch tool. The Fed's monetary policy committee is set to meet between March 14 and 15.

In Europe, the pan-European Stoxx-600 index was around 0.05 percent lower on Tuesday morning. In Asia, the Shanghai Composite in China closed 0.27 percent higher, while the Nikkei in Japan closed 0.18 percent lower.

In oil markets, Brent crude traded at around $56.14 a barrel on Tuesday morning, up 0.25 percent, while U.S. crude was around $53.36 a barrel, up 0.3 percent.


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Energy Stocks Are Falling While The S&P Is Climbing -- And That’s A Buying Opportunity

By Michael Brush
MarketWatch
March 7, 2016

One of the stranger things about the Trump rally is that the energy sector has been left behind.

This group should theoretically be a top performer since it’s hampered by regulation and its products are easily exported. This puts energy squarely in the crosshairs of President Trump’s economic policy, of which two core components are reducing regulations and promoting exports.

Yet energy is the absolute worst performer among the S&P 500’s 11 sectors this year. It was down 5.5% through Monday, compared with a 6.1% gain for the S&P 500 SPX, -0.33% Exxon XOM, +0.45% one of the best-quality names in the space, is trading near 52-week lows. UPDATE

What gives with energy? And is the weakness a buying opportunity?

My take is that the group looks like a buy, for the following reasons.

Insider Vote Of Confidence

Let’s start with the insiders. I’ve tracked insiders for clues about the market for decades, and their buying is a core part of how I come up with a short list of stocks to research for my stock letter Brush Up on Stocks. Two key lessons on insiders support a bullish call on energy now.

First, energy insiders tend to be among the more accurate buyers (though of course like all insiders they can be early). Second, whenever you see a broad swath of insiders buying a group on a pullback, it can be a good signal that it’s time to overweight the group.

That looks like the case with energy stocks right now. Over the past few weeks there’s been significant insider buying in over a dozen energy stocks, including Halliburton HAL, -0.13% in services, Hess HES, +0.00% Oasis Petroleum OAS, +0.92% and Matador Resources MTDR, +0.50% in production, and Marathon Petroleum MPC, -0.23% in refining. (I’ll list the others, below.)

To find out why insiders are buying the group, I recently checked in with three sector experts who know the sector a lot better than I do, because they’ve been following it every day for years.

The bottom line: There’s a plausible case to be made that investors are selling energy stocks for reasons which don’t really add up. If so — and the insiders are confirming this — then the energy sector is a buy. I’ll suggest a few energy names that look attractive in a second. But first, here’s why investors are selling this group, and why they might be wrong.

Inventories Rising


Late last year, Organization of the Petroleum Exporting Countries agreed to impose tighter production quotas starting Jan. 1. Ahead of that, OPEC members produced like crazy to get as much oil on the market ahead of those restrictions.

It takes six weeks or more for oil to arrive by boat to the U.S., the market of last resort for energy. But as it did, U.S. inventories began to build this year, unsettling investors. “The market looks at the big build up in U.S. inventories and gets nervous,” says Jonathan Waghorn who helps manage the Guinness Atkinson Global Energy Fund GAGEX, -0.14% Investors are still shellshocked after a U.S. inventory glut helped suppress oil prices and crush energy stocks two years ago. So any sign of a repeat has them selling.

But they might be worrying too much about this. The current inventory buildup is due mainly to that heavy OPEC production ahead of the new quotas, which makes it a one-off event. U.S. inventories should start to ease at some point, and oil prices and energy stocks may rise as a result. “I think inventory will start dropping and oil will start moving higher, possibly this month,” says Mike Breard, energy analyst at Hodges Capital Management. Waghorn thinks it could take a bit longer.

U.S. Producers: They’re Baack!


Thanks to higher energy prices, U.S. shale producers are back. They’re deploying a lot more rigs. The rig count is back up over 600 compared with a low of 316 in May 2016 — and they are fracking a lot more. This also brings back bad memories of hefty losses for energy investors.

That’s because excess U.S. production — combined with the tactical flood of oil from Saudi Arabia meant to destroy U.S. supply by suppressing oil prices — was one of the main reasons a lot of investors lost their shirts in energy stocks starting in 2014. Now, investors are watching the rising U.S. rig count and thinking, “Oh no, not again.” So they are getting out of energy stocks.

But worries about excess U.S. production may well be a false fear for the following reasons.

• First, as U.S. producers cut back over the past few years, they naturally kept their best wells online. Now, as they add production they are bringing on less efficient wells, or “low grading.” And service companies are going to continue to hike prices, reversing concessions made during the bad days, points out Credit Suisse energy analyst Jan Stuart.

The upshot: Production might not ramp as quickly as investors worry. At some point producers will need to wait for higher prices, to make it worthwhile to add these less efficient wells. “You don’t get as much oil for your money in the future. So U.S. producers will need higher prices to increase production,” says Waghorn.

• Besides, U.S. producers are only a piece of the oil price puzzle, and a relatively small one at that — responsible for about a 10th of global production. Elsewhere in the world, production restraints are likely, which tells us oil prices may move higher.

OPEC, for example, will probably remain disciplined on production because of national budget constraints in Saudi Arabia, says John Groton, director of equity research at Thrivent Financial, who has followed the energy space for years. He thinks Saudi Arabia needs oil in the upper $60-per barrel range to balance its national budget. Oil CLJ7, +0.26% has traded recently in the mid-$50 range.

And in regions outside of the U.S. and OPEC — responsible for about half of global production —- capital spending was “utterly destroyed” during the recent bout of low energy prices, says Waghorn. These energy producers will be slow to bring that spending back online.

In any case, projects take years to complete. So production from this source of supply probably won’t increase, and it is likely to decline.

Meanwhile, global demand will continue to rise because most of the major economies in the world are expanding.

The bottom line: Oil will move up from here, probably to around $70 a barrel over the next three years, believes Waghorn, the manager of the Guinness Atkinson Global Energy Fund.

One For The Quants

Here’s one more reason energy stocks look like a buy: Oil prices and energy stocks are oddly out of synch.

During the first two months of the year, the MSCI World Energy Index underperformed world markets by 10 percentage points, says Waghorn. Since the start of the year, the MSCI Energy Index is down 5.0%, while the MSCI World Index is up by 5.3% through early March.

This is highly unusual. It has only happened 21 times since 1983. Even more unusual: Energy stocks have been going down in the past few months while oil prices have been going up — at least slightly. This has only happened three times over the past several decades (January 1999, October 1987 and April 1986).

Quants look for unusual anomalies like these because trends often revert to the mean. Indeed, energy stocks outperformed the market substantially six months to two years after each time we’ve seen this anomaly, says Waghorn. Given the overall supply constraints and the slim chance of a quick snap back in U.S. production from here, that seems probable.

How To Play This


One way is to simply buy funds dedicated to investing in the group, like Waghorn’s fund.

Another is to follow the insiders. Besides Halliburton, Oasis, Matador, Hess and Marathon Petroleum, which has a four out of five star rating at Morningstar, insiders were also recently buying in significant amounts at Carrizo Oil & GasCRZO, +1.92% Parsley Energy PE, +0.44% Newfield Exploration NFX, -1.04% Energy XXI EXXI, +6.21% SM Energy SM, +2.38% QEP Resources QEP, -1.35% Martin Midstream Partners MMLP, -2.12% Plains GP PAGP, +0.42% Panhandle Oil and GasPHX, -0.76% and Parker Drilling PKD, -2.63%

Breard, at Hodges Capital Management, follows Comstock Resources CRK, +4.75%closely. He has made some great contrarian calls on the company, favoring it last spring when it traded below $4, ahead of a move above $12. He likes the name in the current pullback into the $8-$9 range. “Comstock looks awfully cheap,” he says, especially considering that over the next several weeks they are bringing several wells online in untapped territory, which suggests they will be particularly productive. He also likes Parsley Energy. which he says has good properties in the Permian and Delaware basins.

Top holdings at Guinness Atkinson Global Energy Fund include Newfield, Devon Energy DVN, +1.36% Carrizo, QEP Resources, Apache APA, +0.19% Occidental Petroleum OXY, -0.20% ConocoPhillips COP, +1.05% and Noble NE, -4.44%

What about Exxon? If oil prices really are going back up to $70 over the next few years, it might not be the best energy name to own. In this scenario, investors will favor smaller, lower quality energy companies that use more leverage to fund development over more conservative, larger players like Exxon, Chevron CVX, -0.33% and ConocoPhillips.


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Trumponomics 101: Good Riddance To Eight Years Of Obama Budget Chaos

President Trump will unveil his first full budget in May. What can America expect?


The National Interest
March 7, 2017

President Trump has inherited a national debt of nearly $20 trillion and a deficit projected to rise rapidly over the next decade. Working through the nation’s fiscal mess won’t be easy, but it will be necessary if he and Congress hope to unleash economic growth and secure the blessings of economic opportunity and prosperity for current and future generations.

What’s needed is a new era of fiscal responsibility and spending control. Assuring America’s investors, both foreign and domestic, that the country has a concrete strategy to stop out-of-control spending and debt will enhance confidence and encourage investments in the U.S. economy and jobs.

Any tax relief Congress and the president can deliver this year will be short-lived in the absence of consequent spending controls that bring spending and revenues into closer alignment. Out-of-control spending and debt threaten higher future taxes as interest costs rise to consume an unsustainable share of the budget.

Current Congressional Budget Office projections show interest payments growing to $768 billion by the end of the decade. The prospect of having to spend more on debt service than on national defense would deeply trouble any commander-in-chief.

The budget process is a key tool that is used to control spend and debt. The president kicks off the budget process by presenting his vision to Congress every spring. Congress then follows with its own plan, encompassing all spending and taxes in one concurrent budget resolution. After the House and Senate agree on a plan, that budget can kick off reconciliation, a powerful tool to write implementing legislation that carries out the goals set in the budget. Simultaneously, appropriators begin drafting spending bills to allocate funds for defense and nondefense discretionary programs as well as certain other appropriations.

At least, that’s how the process is supposed to work. But it does not always operate smoothly. In fact, most years Congress and the president rely on one shortcut or another, such as a continuing resolution or omnibus spending package, to fund federal government operations. Regardless, legislators have all the tools in their arsenal to make important budget reforms, as long as they are willing to use them.

President Trump’s first budget plays a key role in this process. Reports indicate that he will deliver it in two parts. First, he will release a so-called skinny budget in mid-March. This submission will focus on the one-third of the budget for which Congress appropriates funding every year, called discretionary spending. Then, the president is expected to issue his first full budget in May. In addition to discretionary spending, the full budget will include mandatory spending (the so-called entitlement programs) as well as a tax plan and other policy proposals.

The skinny budget, we learned, will reprioritize defense spending and reverse eight years of Obama-era shifts in spending from a core constitutional priority toward the president’s domestic pet projects. That’s encouraging, especially if all of the increase is offset with immediate spending reductions in nonessential domestic programs.

My Heritage Foundation colleagues and I have identified more than $80 billion in domestic discretionary cuts that could be made right away. Our congressional budget proposal lays out in great detail where and how those cuts can be made.

Net cuts in discretionary spending are critical to reducing the size and scope of the government and enhancing individual and economic freedom. They also make an important down payment toward the federal deficit and debt.

Smart cuts can “drain the swamp” by weaning special interests from feeding unfairly from the federal trough. They can also streamline the bloated federal bureaucracy and empower the private sector—as well as states and localities—to absorb functions the federal government has improperly usurped.

This approach will unleash innovation, economic growth and jobs that have been hindered by an overreaching federal bureaucracy. Much good can come from rightsizing the federal government and reviving federalism, if properly conceived.

Success in controlling federal spending and debt, however, depends heavily on reforms to federal health care programs and social security. These programs already consume more than half of the annual federal budget, and they are growing rapidly.

Without reforms, nearly 85 cents of every additional dollar in spending over the next ten years will go to federal health care programs, social security and interest on the debt. This is why entitlement reform must follow closely behind efforts to streamline the federal bureaucracy.

It’s quite smart to focus on attainable, meaningful goals early in a new presidency. If President Trump and Congress can show the American people that they are serious about reining in federal agency overreach and cutting programs that cater to special interests, perhaps they can build trust with the American people to tackle the bigger fiscal challenges.


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