Taal selectie



Pascal Blackburne & Luc Synaeghel 2017-05-05

At the risk of repeating ourselves, let us begin this letter by pointing out the striking dichotomy between solid – indeed improving – European economic fundamentals and a political agenda that is rife with potential pitfalls.

On the latter front, two hurdles have admittedly been cleared with Wilders’ Party for Freedom not winning the Dutch elections and the first round of the French presidential election not bringing about a Mélenchon-Le Pen duel. But the road ahead remains challenging. In France, whoever of Macron or Le Pen is elected, the June parliamentary elections will be a difficult hurdle to overcome. A legislative majority is key for the President to be able to deploy his/her program. If elected, Macron will have only weeks to put forward candidates across the country – with defectors from other parties being the most liable to succeed – or to form alliances. As for Le Pen, while her party may well up its parliamentary presence, gaining sufficient support to push through “Frexit” seems a far cry (particularly since it is not wanted by the French people at large).

More problematic for the future of the European Union would be a possible call to the polls of Italian voters

The French vote will be preceded by the UK snap general election and followed by the German federal election, both of which look benign at this point. More problematic for the future of the European Union would be a possible call to the polls of Italian voters. And then there is the US political scene, which has so far seen more posturing than achievements. How patient will the richly valued US equity market be with respect to corporate tax reform? Can a middle-ground on that subject even be found between President Trump’s “simple” tax cut proposal and the Republicans’ broader project? And what if the situation with North Korea were to degenerate? From an investment perspective, these many moving political parts are forcing us to adopt a briefer than usual time horizon when it comes to index exposure – standing ready to adjust our position at short notice. As the year rolls on and political uncertainty is gradually removed, we expect fundamentals to regain prominence and allow for a more durable position in European equities. The combination of positive corporate earnings surprises, “reasonable” valuation and a still accommodative central bank certainly looks appealing.

In the meantime, we keep our longer-term perspective to specific investment themes: bulk shipping and U.S. shale oil producers notably. The first contributed significantly to our overall robust first quarter performance. And although they did give back their March upside during the month of April, their underlying investment case remains very much on track. As for the shale oil story, it has yet to begin to unfold. As we pointed out last month, investors remain overly focussed on “sticky” weekly US crude inventory data. We continue to expect the crude price to eventually turn up, perhaps in the wake of the forthcoming OPEC meeting. We invested in shale oil producers with an eye to an 2018-2019 exit window – and recognize that the route leading there will be volatile, requiring patience, active management and diversified exposure.

European electoral agenda – an update

As we put pen to paper, the question on all minds is who will be the next French President. Financial markets would obviously prefer a pro-Europe Macron outcome – meaning that a Le Pen victory is liable to trigger a near-term correction.

The true test will come in June, with the French parliamentary elections.

But, we would argue, regardless of who moves into the Elysée Palace, the true test will come in June, with the French parliamentary elections. They will determine whether the new President has sufficient backing in the National Assembly to implement his/her political program, indeed even just to govern. With Macron lacking a historically established party, obtaining a good number of congressional seats will be complicated. Alliances are his other option – but on which side of the political spectrum? And how solid will they prove?

As for Le Pen, although a multiplication of candidates at the constituency level could work in favour of her party gaining some congressional presence, achieving sufficient representation to be able to push through her Eurosceptic policies seems very unlikely. All the more so since a majority of the French people seem to be against the very idea of leaving the Eurozone and/or the European Union.

Turning to the UK, we see May’s call for a snap general election on June 8 as a smart political move. And from the viewpoint of investors, it holds no risk of a negative surprise. Either May comes out with a larger majority in the House of Commons, giving her a stronger position to lead “Brexit” negotiations, or she loses her majority and “Brexit” is all but gone (perhaps via the holding of a second referendum). As such, while the UK vote does add to an already heavy 2017 European electoral agenda, we do not see it as cause for particular concern.

The same goes for the German federal election in September. As we wrote a couple of months ago, investors should in our view not fret about a possible Merkel defeat against challenger Schulz. While Merkel is widely (and rightly) regarded as a pillar of the European construction, her main opponent holds also a clear pro-European Union attitude, as do most of the candidates within her own party who could take her place should she decide to retire before the election.

Where the political “black swan” really hides is in Italy. Right now, there is no talk about holding elections ahead of their 2018 due date. Renzi himself, despite having just regained leadership of the ruling Democratic Party, seems aware of the risk that such a scenario would entail, for the country and for the European construction at large. If elections were to be held in Italy later this year, a victory of the populist Five-Star Movement could by no means be excluded – wreaking havoc in financial markets.

Frustrating times for oil investors

Whereas equity investors have been willing to climb a wall of political worry, oil market participants seem intent at looking at the glass half empty rather than half-full. They have focused on the lack of decline in US crude inventories, despite a body of broader positive evidence.

Why is the most widely-watched measure of oil inventories not declining? Let us attempt to respond by looking at the components of the oil equation in its most basic form:

Production - Consumption = Change in Inventories

On the supply side, first quarter US production grew by some 500’000 barrels per day on a year-over-year basis. This increase is mostly attributable to shale oil (the rest coming from the Gulf of Mexico) but it would be a mistake in our view to extrapolate the trend linearly for the full year. Much of the additional shale oil production during the first quarter was produced out of “drilled but not completed” wells – heritage of the crisis years. By definition, those wells can only be put to work once. Improved technologies also enabled the output of existing wells to be upped, with the caveat that they will then be empty sooner than planned. Our forecast for year-end is thus that US shale oil supply will be up some 800’000 barrels per day vs. 2016.

Rising supply and falling demand: no wonder US inventories did not drop during the first quarter!

Rising first quarter US supply was met by declining demand – in tune with the soft economic patch (latest estimates point to GDP growth of only 0.7% vs. expectations of 2% just a few months ago). Again, though, it would be a mistake to infer that US oil consumption will continue to fall. Part of the first quarter contraction can be explained by warmer than usual weather.

Rising supply and falling demand: no wonder US inventories did not drop during the first quarter! That said, the oil equation becomes more complex – and very unstable – when imports and exports are factored in. Their fluctuations are such that looking at US inventories on a weekly basis frankly becomes a matter of gambling more than analysis.

We would also argue that US inventories do not paint a complete picture. At the global level, we know that OPEC (and Russian) production is down around 1.6 million barrels per day vs. last October – cuts that, we are confident, should be extended at the forthcoming OPEC meeting. Saudi Arabia needs a higher crude price not just for budgetary reasons but also because of its plan to partially privatize state producer Aramco next year. We also know that world economic growth will be higher this year than last, driving up total oil demand. And with overall oil consumption now exceeding production, it follows that a resorption of global crude excess stocks is underway – even if not yet visible in the most watched locations (notably the US).

Until further evidence of the global inventory contraction becomes available, it is difficult to see a marked upward move in the oil price. But we continue to believe that patient investors will be well rewarded in the longer term. Put differently: now is not the time to capitulate.

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