Crude oil set to top as OPEC angles for more production cuts: portfolio manager

Peter Kenny
Peter Kenny

By Peter Kenny, chief market strategist for Global Markets Advisory Group and owner of KennysCommentary.com

Themes:

  • Questions regarding tax reform legislation loom large for Wall Street this week
  • Concern over the impact of reduced or eliminated tax deductions weigh on investors
  • CFPB’s chief Cordray resigns, questions remain over who has authority to name new head
  • Holiday shopping season off to a strong start led by e-commerce growth
  • OPEC and allies meet this Thursday in Vienna to discuss production and pricing models
  • Crude oil’s recent run-up to two-year highs, due for a pause and potential reset
  • With Black Friday behind us, today’s Cyber Monday takes center stage

Narrative:

US equity markets moved incrementally higher and further into record territory in Black Friday’s abbreviated session, with the Nasdaq, S&P 500 and Dow Industrials ticking higher. Volume, as expected, contracted from Wednesday’s light trade. For the week, all three major equity indices posted gains. The Nasdaq led the way with a gain of 1.6% while the Dow Industrials and S&P 500 both tacked on 0.9%.

Economic data from last week was largely in line with or stronger than expectations. Leading indicators for October came in at 1.2%, double the expectation of 0.6%. Existing home sales for the month were a slightly stronger 5.480M versus 5.440M consensus. In something of an aberration from recent trends, durable goods orders for the month contracted by 1.2%, reversing three months of gains. Weekly jobless claims, the Bloomberg Consumer Comfort Index and Consumer Sentiment all remained in line and encouraging.

This week’s economic calendar is significantly busier that last week’s. Today, October new home sales rose an unexpected 6.2% (685k vs. 620k consensus) — the highest level in a decade. The Dallas Fed Manufacturing Survey printed a 19.4 for November vs. expectations for 24.5. S&P Corelogic Case-Shiller HPI (c. 0.4%) and consumer confidence (c. 124.3) are released Tuesday. The preliminary Q3 October GDP figures on Wednesday are expected to reflect further acceleration. The prior reading was 3.0%. Bloomberg consensus has this reading at 3.3%. Motor vehicle sales, PMI manufacturing and ISM manufacturing round out a busy week. There are 10 Fed talks scheduled, three of which will be given by William Dudley. The most important of the talks will be given by outgoing Chair Janet Yellen on Wednesday at 10:00 a.m. EST.

Retail sales, which proved to be significantly better than expected on Black Friday, and the expectations for a pending legislative push on tax reform, both played a hand in the day’s trade. On Thanksgiving week’s Thursday and Friday, US retailers posted nearly $8 billion in online sales according to Yahoo Finance. Cyber Monday sales are expected to approach $6.5. Electronic games, entertainment appliances and laptops were aggressively marked down and sold in volume. Results from traditional brick-and-mortar retailers are expected to be very strong and will be available early this week.

While Washington, D.C., gets closer to voting on tax reform legislation, voices in opposition have become increasingly strident. Even some of those expected to support the principle of tax reform are wavering in their support. In many respects, the tax reform legislative flight path is eerily similar to that of the ACA “Repeal and Replace” effort. Much of the run-up in equity prices that we have witnessed over the past several months has been predicated on tax reform success by the GOP. Anything that resembles a failure along the lines the GOP effort to unwind ACA would have negative consequences for equities.

Crude oil likely at the top of its range

Given the methodical run-up in crude prices that has materialized in recent months— with WTI crude rallying nearly 40% since June and closing at a near two-year high on Friday at $58.95/bbl — energy-focused investors have once again found themselves at a potential pivot point.

This Thursday, OPEC is scheduled to meet in Vienna to discuss production, output and price modeling, among other agenda items. Given the significance of this meeting in conjunction with the dramatic price appreciation that has materialized in recent quarters, we are likely to see a modest pullback in crude prices this week as investors take some chips off the table as a way of mitigating a degree of risk heading into Thursday’s meeting.

There are other reasons why crude oil prices may run-up against near-term resistance. Specifically, the focal point of this meeting involves the current production agreement that is set to expire in March, 2018. That deal, as it currently stands, removes 1.8 million barrels of oil per day from global production. Though not expected, obviously any indication that the agreement will not extend beyond its current deadline would naturally act as a trigger for prices to move lower.

Other themes that could potentially negatively impact pricing for crude include the practical limitations of trying to convince non-OPEC producers of aligning their production schedule with OPEC’s. Historically over time these efforts have had little impact on the actual production of crude. Attempts at production compliance, a cornerstone of the current agreement, have also proven not to hold over time. Ultimately the long term success of this effort by OPEC to tighten supply and support prices will be determined by factors outside its control.

That’s where US shale oil production comes into play. US shale oil supply has been extremely disruptive to OPEC control over global crude pricing over the past several years, as we all know. Though with crude’s precipitous drop below $30/bbl, shale oil became non-economic to produce—at near $60/bbl that changes. At these levels, shale oil becomes a competitor to OPEC.

Given the stability energy prices have provided the global economy over the past two years and therapeutic impact they have had on inflation, policy makers and investors would ideally like to see current production goals extended. However, even if the current agreement is ratified and set as policy moving forward past March, crude oil will ultimately have to compete with shale oil at roughly $60/bbl. As a result, the top end of crude’s range is likely near.

The old adage, “Buy on the rumor, sell on the news” comes to mind.

——————————————————-
WTI Crude Oil (Nymex) (CL=F) $58.24/bbl
Gold (Comex) (CL=F) $1,298.60/t. oz.
10-year Treasury Note yield (CBOE) (^TNX) 2.329%
Volatility S&P 500 (^VIX) 9.88
——————————————————-

Commentary by Sam Stovall, chief investment strategist at CFRA Research

We continue to expect the FOMC to raise rates at its December meeting by 25 basis points. We also anticipate as many as three more rate hikes next year, pushing the fed funds higher by a full percentage point by the end of 2018. Reasons for the FOMC to maintain its tightening pace include the expectation that the year-over-year change in core CPI will reach 2.1% by the final quarter of next year, thus shifting from a net-negative real-rate environment to a neutral one. We also don’t see the mid-term elections staying the Fed’s hand. The FOMC raised or lowered the discount or Fed funds rates in 12 of 16 mid-term elections since 1954. Granted, the Fed cut rates more times in the four months prior to the mid-term elections than raised them (12 separate cuts vs. 8 hikes), with the longest one-way moves being five successive pre-election hikes in 1978 and five straight cuts in 1982.

Economic Calendar:

Monday
Neel Kashkari, 6:30 PM
William Dudley, 7:00 PM

Tuesday
8:30 AM International Trade in Goods
9:00 AM FHFA House Price Index
9:00 AM S&P Corelogic Case-Shiller HPI
10:00 AM Consumer Confidence
10:00 AM Richmond Fed Manufacturing Index
William Dudley, 9:15 AM
Jerome Powell, 10:00 AM

Wednesday
8:30 AM GDP
8:30 AM Corporate Profits
10:00 AM Pending Home Sales
10:30 AM EIA Petroleum Status Report
2:00 PM Beige Book
William Dudley, 8:30 AM
Janet Yellen, 10:00 AM
John Williams, 1:50 PM

Thursday
8:30 AM Weekly Jobless Claims
8:30 AM Personal Income and Outlays
9:45 AM Chicago PMI
9:45 AM Bloomberg Consumer Comfort Index
3:00 PM Farm Prices
Robert Kaplan, 1:00 PM

Friday
Motor Vehicle Sales
9:45 AM PMI Manufacturing Index
10:00 AM ISM Mfg. Index
10:00 AM Construction Spending
1:00 PM Baker-Hughes Rig Count
James Bullard, 9:05 AM
Robert Kaplan 9:30 AM

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