Mastering Expectations

Shawn-00397_cmykby Shawn Narancich, CFAExecutive Vice President of Research

 A Tradition Unlike Any Other

 As another Masters golf tourney gets underway in Augusta, Georgia this week, investors are beginning to process the first reports of a dawning earnings season; as well, they have been jolted by a strong dose of deal news this week totaling well over $100 billion in announced acquisitions. Whether this flurry of activity heralds meaningfully more late-cycle deal making remains to be seen, but low interest rates as well as low oil prices support the rationale for energy deals like Royal Dutch’s $70 billion purchase of British energy company BG Group. Speculation is rife that rivals Exxon and Chevron could be compelled to do the same. Although buying another European producer might make more sense now in light of the strong dollar, we view neither of these integrated oil producers as likely to attempt a large deal for a major peer. More likely are deals for smaller independent U.S. producers with quality acreage in key Texas shale plays like the Permian Basin and the Eagle Ford.

Ready, Fire, Aim

As Royal Dutch jockeys for position in Big Oil, energy investors attempting to divine the low in prices for this cycle were forced to confront the not-so-shocking news out of Iran that that their “supreme leader” Khamenei is calling for the immediate lifting of economic sanctions in return for concessions limiting the country’s nuclear program. As well, he apparently disdains the idea of nuclear inspections that would confirm the country’s compliance with key provisions of the agreement reached in Switzerland last week. All of which leads us to conclude that predictions about a wave of new Iranian oil buffeting the markets any time soon is premature. From our perspective, the likelihood of reaching a final nuclear agreement with Iran looks increasingly unlikely.

Skating to Where the Puck Will Be

Geopolitics aside, we believe oil prices have bottomed and that markets will tighten meaningfully in the second half of this year, pushing prices closer to the marginal cost of production estimated to be somewhere between $75 and $100/barrel. From an investment perspective, we are overweight the energy sector and favor upstream producers and the service companies that enable their production as the two groups most likely to benefit from rising oil prices.

And They’re Off!

Alcoa marked the unofficial beginning of first quarter reporting season by announcing better-than-expected earnings on healthy growth in aluminum demand from both the aerospace sector as well as the emerging market in autos. Unfortunately for shareholders, the results met with a thud by investors who drove the stock down 3 percent on fears that aluminum prices will succumb to excess supply from China, the world’s largest producer. Next week will mark the first full week of earnings, with the money center banks and a few select industrial and healthcare companies on tap to deliver their numbers. In contrast to depressed energy results amid low oil prices, we expect earnings growth from sectors like healthcare and technology.

Our Takeaways from the Week

  • Deal making is being stimulated by low oil prices, low interest rates and a strong dollar
  • Investors are beginning to turn their attention to first quarter earnings