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- The Weekend Edition # 121 - Oil Market Update & Earnings Multiples
The Weekend Edition # 121 - Oil Market Update & Earnings Multiples
US CRE fears remain limited; Fundamentals causing oil to rise; Earnings Growth vs. Multiples; Taking some profits
Ayesha Tariq
February 10, 2024
Welcome to another issue of the Weekend Edition!
Thank you to all who’ve read and welcome to all the new subscribers this week!
Here's what we cover
Market Recap - Big Tech still leading
February 05 - February 09, 2024
US equity markets seem unstoppable - at least the S&P 500 and the Nasdaq. Earnings have driven a significant portion of this price action (as we shall see in the Earnings segment below).
Despite sporadic discussions of later and fewer rate cuts, we see price action continue higher.
Breadth has improved somewhat but still remains quite weak. Big tech remains the leader, and mostly still because of cloud growth and AI. This week we shared a fantastic investing idea for premium members - Ciena - a company that provides network services to keep up with the cloud and AI infrastructure demands.
We did some fear in the market but that was limited to US commercial real estate. While it continues to remain a worry, credit fears have not seeped through to other sectors. If anything, the recent SLOOS report showed banks are easing up on credit standards and loan demand is increasing.
From a sector perspective, tech led the week (not surprising!), while healthcare and industrials were in the Number 3 and 4 positions.
Commodities
Oil is gathering momentum and we will talk about it in detail below. But, keep your eye on Agriculture as gains were led by Cocoa and Coffee. The ETF DBA - the Agriculture ETF, gained over 2% this week.
Some of the charts in the recap section have been sponsored by Koyfin. We have a special discount of 15% for MacroVisor readers for any new sign-ups to Koyfin. To take advantage of this promo please sign up here - Koyfin MacroVisor Discount
Macro - Oil Fundamentals for Q1
This week oil started to see some bullish momentum. One way we look at this is by seeing the oil breaking out above the middle band of the Bollinger Band, which is also the 20-day moving average. The Relative Strength Index (RSI) is also increasing which provides some confirmation of the upward trend.
Oil prices have been volatile though, and it’s always better to be prudent. We’re seeing Oil volatility (OVZ) decline below the mean which is a signal of rising prices but, the volatility still remains within one standard deviation, meaning it’s not stretched.
This is a good time to understand some of the supply and demand fundamentals influencing oil prices in the near term.
Oil Demand Dynamics
We’re seeing softer demand dynamics for oil. This is expected as global growth slows down.
Chinese demand is still running behind normal. China still remains in deflation with CPI numbers coming in at -0.8% YoY, the lowest level since 2009. Goldman Sachs estimates that Chinese demand for oil is still 15 million barrels per day (bpd) lower than usual.
Warmer weather in parts of Europe and Asia has led to lower demand for heating oil and crude.
While demand has been sluggish, as we see industrial production and global manufacturing PMI numbers improving, we’re likely to see some increase in the demand for oil. China will continue with central government planned projects and India’s latest budget shows a focus on infrastructure spending.
Oil Supply Dynamics
On the supply side, we’re seeing mixed dynamics. On the one hand, we’ve had record crude production from the United States, while on the other hand, we’ve had OPEC cut output quotas to lower supply. Finally, we’re also seeing the geopolitical tensions in the Red Sea create upward pressure on prices.
Russian liquids production and exports were reduced in January due to winter storms and adhering to the OPEC+ quota.
OPEC production was also lower in January by about 400,000 barrels per day, mainly due to the shutdown of a Libyan field and lower production from Kuwait. The UAE and Iraq continue to pump over their quotas. Saudi is sticking to its quota with an output of below 9 million barrels per day.
US Production is starting to wane. Production in the Permian Basin and a certain extent, in the Gulf of Mexico, has declined over the last several weeks.
Red Sea tensions have cut oil flow through that area by about 50%. About 7 million barrels of oil moved through the Suez Canal in 2023, and this is now down to about 3.2 million barrels. With longer journeys, we are now seeing:
More oil stocks on water and it is estimated that every 15-day delay could increase prices by about $1 per barrel.
Freight rates for refined products are up $2 per barrel or 29% while rates for crude are 30 cents per barrel or 9%.
Global oil inventory has been building but January has seen a stock draw. The EIA estimates Q1 will see this stock draw continue, as demand exceeds supply.
Finally, we have the OPEC+. While there was no significant discussion on the output quotas during the last meeting, the meeting during the first week of March should come up with a decision. Our view is that they keep the extended cut of 2.2 million barrels per day in place until mid-2024 and the lower cut of 1.7 million barrels per day thereafter, at least until the end of the year.
Bottom Line: Oil prices should remain somewhat elevated during this quarter.
Earnings Season - Growth vs. Multiples
This quarter, earnings are making a nice positive reversal. We’re now seeing a blended earnings growth rate of +2.9%. After several quarters of negative to near-zero, this is a welcome number.
Growth is being led by big tech but, as we pointed out last week - healthcare, energy, and industrials are all posting positive growth. Having said this, the S&P 500 making all-time highs is definitely causing an increase in valuations - and not just overall valuation but the valuations for the sectors also remain higher than the 25-year average.
We’re still looking at a multiple expansion story for next year to lead the S&P 500 higher, instead of strong earnings growth. As the Fed normalizes interest rates, multiples can be supported but I’d much rather have the earnings growth. In that vein, I look at this excellent chart from Barclays.
Looking at a comparison between Big Tech, and the rest of the SPX - we see that Big Tech is being driven by a mix of earnings and multiple expansions, more by earnings. In contrast, the rest of the SPX seems to be driven solely by earnings growth over the next 12 months which is perhaps the reason that there is a massive divergence in prices between Big Tech and the rest of the S&P 500.
But what interests me more are the sectors - Industrials and Healthcare are driven more by earnings than by multiple expansion, while it’s the opposite for Energy. There are definitely opportunities brewing when it comes to the first two sectors. As for Energy, earnings are growing and that could definitely start driving prices sooner rather than later.
The Week Ahead - Calendars
US Earnings
US Economic Calendar in Eastern Time (Source: Trading Economics)
Closing Thoughts - Taking some profits
Positive GDP growth and positive vibes in ISM / PMI numbers suggest we may get a hot inflation print.
With the Fed taking March cuts off the table, the US Dollar is likely to remain relatively strong, and a hot inflation print could cause a bear steepener. Longer-term rates will put pressure even on Big Tech and we could see a correction in these names, particularly with earnings behind us.
We also have the monthly Options Expiry next Friday and that could cause some volatility in the market.
It may be prudent to take some profits ahead of the inflation print. You know what they say:
“No one ever went broke taking profits”!
Have a great week ahead!
Sincerely yours,
Ayesha Tariq, CFA
There’s always a story behind the numbers.
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