Investors facing trade storm clouds on the horizon heading into Q3

Peter Kenny
·Peter Kenny

By Peter Kenny, founder of Strategic Board Solutions and owner of KennysCommentary.com

WTI crude is flying high again after posting its best day in 6 months on Friday, and the near-term direction for crude prices is becoming clear.

Last week’s OPEC meeting provided for some interesting trading in energy markets, particularly on Friday. The production deal signed off on by OPEC on Friday allows for a nominal boost in production, to the tune of 1 million barrels per day. However, given the simple nature of the lift in output relative to global production and the lack of specifics in the announcement, many industry observers were left a bit confused. Even cartel and non-cartel members seemed to have their own take on the announcement in a follow-up press conference on Saturday. After gaining fractional ground in the early stage of the week, on Friday, WTI crude spiked 5.71% higher and in the process posted its best one-day performance in nearly six months.

Adding a degree of confusion to the trade was the realization that many members of the cartel are not in a position to raise production irrespective of the announced increase in production. The production announcement was a win for Saudi and Russian interests as they are the two producers most capable of increasing production.

There are a significant number of variables at play concerning crude pricing moving forward from Friday’s announcement. Venezuela’s energy sector has collapsed in recent years — effectively having the effect of tightening a production restrained global supply. Additionally, concern over the impact of potential American tariffs aimed at the EU and China are adding a degree of complexity to the equation. The latest presidential threat against any Iran imports by US allies throws another wrench into an already complicated situation.

Suhail Mohammed Al Mazrouei, United Arab Emirates’ energy minister and president of the OPEC coneference, speaks during the 7th Organization Of Petroleum Exporting Countries (OPEC) international seminar in Vienna, Austria, on Wednesday, June 20, 2018. Iran put itself on a collision course with Saudi Arabia at this week’s OPEC meeting, rejecting a potential compromise that would see a small oil-production increase to appease energy consumers. Photographer: Stefan Wermuth/Bloomberg

On Saturday, the OPEC ministers, specifically those from Saudi Arabia, made it clear that they would do whatever it takes to keep crude markets in balance — in a nod to both President Trump and the fragile state of our on-going global growth. Given the rising rate of inflation and other measures of economic performance that speak to current near-optimal performance, any cost-push inflation as a result of sharply higher energy prices would have a negative impact on the global economy. Disrupting the current rate of global growth could inflict harm on the cartel and its control over pricing.

This week’s EIA Petroleum Status Report for the week ending 6/22, is due on Wednesday. Last week’s report reflected a draw on crude inventories of 5.9 M barrels while gasoline (+3.3M/bbl) and distillates (+2.7M/bbl) saw inventories rise. It was mixed. However, the dramatic draw on inventories played into the OPEC narrative on Friday – effectively lighting the fuse for the Friday melt up which allowed for WTI crude prices to rally sharply.

It probably goes without mention that though this week’s economic calendar is active, Thursday’s release of Q1 GDP reading will deservedly garner the lion’s share of investor attention. The last Real GDP reading Q/Q change SAAR was 2.2%. The GDP price index – Q/Q change SAAR was 1.9%, and Real Consumer Spending was 1.0%. Econoday consensus is calling for a final reading of 2.2%. Given that GDP represents the total value of our production and purchases in the quarter, and given that is it the broadest metric of measure for our economic health, it will likely have an impact on investor outlook both this week and well into Q3 if there is a significant deviation from the previous reading.

The balance of this week’s economic calendar has plenty in it to keep investors’ attention. Manufacturing will be a focus this week. Monday, the Dallas Fed Mfg. Survey Production Index came in at 23.3, with the General Activity Index printing 36.5, beating the high end of Wall Street expectations. The Richmond Fed Mfg. Index today surprised to the upside at 20, and Thursday we get the Kansas City Fed Mfg. Index. As we have discussed for some time now, the manufacturing sector has been a bright spot for the US recovery in recent quarters — much to the surprise of many. With talk of trade wars heating up, the manufacturing sector is seen as being vulnerable. Any weakness in this week’s manufacturing data will likely add additional weight to the headwinds investors have been experiencing in equity markets.

New home sales figures for May came in on Monday at 689K, greater than the Econoday consensus call for 665K. The Conference Board’s Consumer Confidence survey for June came in at 126.4, slightly below the Econoday consensus of 128.1, which itself is at or near multi-year highs. Also hovering at multi-year highs, the University of Michigan’s Consumer Sentiment Survey for June is due out on Friday. Econoday consensus is calling for 99.2 versus May’s 99.3.

Closing out the first half of 2018

We head into the last week of Q2 on a decidedly cautious note. The year-to-date performances posted by the majors speak directly to that in spite of solid earnings and revenue growth across nearly all equity market sectors in the first half of the year. The Dow Industrials, for example, have lost 244 points or .9% YTD. The Dow’s 52-week performance is a blistering +17.84%, but all of that gain came in 2017. The current P/E is 18.54.

The S&P 500 has faired modestly better in the first half having gained 59 points or 2.1%. The S&P 500’s 52-week performance is also solidly positive at +15.20%. Again nearly all of that performance came in 2017. The S&P 500’s current P/E is a more elevated 21.03.

Not unexpectedly, the Nasdaq Composite has by far posted the best YTD performance of the major indices. It has posted a YTD gain of 11.42%. Over the past 52-weeks, the Nasdaq Composite has gained 24.13% and sports a P/E of 23.745.

With the first half of the year wrapping up this week, investors will be focusing on several themes in the second half of the year. Among them: inflation, energy prices, trade wars/tariffs, earnings and the impact of the tax code on the economy and consumer spending.

We discussed some of our views with Reuters recently.

Written by CFRA Investment Strategist, Lindsey Bell:

As trade policy heats up and dominates the headlines, a trade war is getting too close to reality for the comfort of many investors. Volatility has increased as confidence wears thin among investors. With limited news flow from corporations as we get into the heart of summer, we believe the unusual increase in volatility is likely to continue at least until earnings are released for the second quarter in mid-July. FedEx, an early reporter given its off-cycle quarter that ended in May, voiced concern about the current trade situation on its earnings call. CEO Fred Smith said, “FedEx supports lowering trade barriers for our customers, not raising them.” Despite that, the company reiterated expectations for U.S. GDP growth of 2.9% in 2018 and 2.7% in 2019. Global GDP growth was also reiterated. Like a well-seasoned CEO, we believe investors will be better served with a long-term focus while trade policies and volatility are ironed out.