Shock & Awe
With change at the economic margin beginning to improve (e.g. recent U.S. payrolls, durable goods orders and manufacturing PMI), investors are beginning to see cyclical elements of the equity market improve. Oil prices are now up year-to-date, energy and industrials are all of a sudden outperforming the broader market, and financials, which so far this year have pulled up the rear, are starting to get a bid. We have continued to espouse a belief that the U.S. economy is not going into a recession this year and, as China exercises fiscal and monetary powers to keep growth afloat in the world’s second largest economy, all eyes this week turned to Europe. Investors everywhere expected monetary largesse from the European Central Bank, and ECB President Mario Draghi did not disappoint.
Ready, Fire, Aim
Although the expected reaction in equities was delayed, the risk-on nature of today’s market reflects heavy artillery unveiled by the ECB. Monthly QE increased by 20 billion euros, QE extended into the realm of corporate debt, and a further (albeit tempered) reduction in the central bank deposit rate to -0.40 percent formed the crux of ECB actions unveiled to stimulate lending in a deflationary European economy. Going into the ECB meeting, currency traders almost universally expected the euro to weaken on forecast expansion of the European monetary base, so we could only chuckle when, of course, the euro rose yesterday! We see puts and takes regarding the dollar price of the euro, but the fact that Europe’s central bank will be buying more government and now company-issued debt is an unalloyed positive for Europe’s economy and global risk-facing assets in general.
The Dawn of a New Bull Market
Believe it or not, benchmark oil is now up 4 percent so far this year and, by commonly accepted definition, has now entered a new bull market, up 47 percent from its February 11 low reached exactly one month ago. We are on record as having stated that $30 oil in 2016 makes as little sense to us as $150 oil did in 2008. With U.S. production rolling over at a faster rate, China guiding 2016 production down by 4 percent, Mexican production in decline and Iran being the only nation with material new volumes to offset declining non-OPEC production, the low price for oil this cycle appears to be in the rearview. The other key component – demand – is buttressed by easy monetary policy in key developed economies and $2 gas prices that have SUVs and trucks flying off dealer lots. Decreasing supply and increasing demand are key to oil markets rebalancing this year. Notwithstanding efficiency gains realized by U.S. producers, a global oil market with relatively little excess productive capacity should push oil toward the marginal cost of production, which we peg at somewhere between $70 and $80/barrel.
Our Takeaways from the Week
- Investors had high expectations for ECB monetary policy action this week and Draghi delivered
- Oil has ascended into a new bull market