In what is by far the most entertaining research report of the day, Canaccord quant Martin Roberge, essentially admits and apologizes for blowing up the bank's energy client returns in 2017 (with an endless long oil reco), but then - in a bizarre follow up - says that while Canaccord overweight rating on energy has been "costly and like many investors, we feel like throwing in the towel on the group. However, being wrong is not a good reason enough to change one’s stance."
Actually, Robert, our gratitude for the best joke of the day aside, being wrong is always a good reason to change one's stance, unless of course you are long stocks, in which case being "wrong" simply means the Fed or some other central bank comes to bail you out the second markets "crash"by 5% or more.
And just to share some of the cheer, here are the key excerpts from Roberge's note, "Mid-Week Market Observations"
What went wrong? The underperformance of energy stocks in 2017 has erased the outperformance in 2016. Our OW stance has been costly and like many investors, we feel like throwing in the towel on the group. However, being wrong is not a good reason enough to change one’s stance. After all, our OW stance has been predicated on four bullish factors: crude inventory draws, rebalancing world oil markets, a weak US$ and valuation of energy shares expanding from key historical supports. Except for the latter factor, most of these bullish elements are playing out. US commercial (and OECD) crude inventories should keep dwindling as long as gasoline inventories stay below their 26-week average (Figure 1).
Second, the extension of the 1.8 MMbbl/d OPEC/Non-OPEC production-cut agreement until next March is enough to rebalance world oil markets in 2017 and 2018 (Figure 2) according to the EIA. Third, the US$ has dipped to multi-week lows with no rebound in sight as long as the US economy lags world economic momentum and the US twin deficit deteriorates (Figure 3).
Last, NA energy stocks are bombed out, trading at a 41% P/BV discount to the market, a new all-time low (Figure 4).
Ok so, the clients are all blown up but the analyst refuses to change his view. At least he offers the following mea culpa, although we doubt it will be of much use to those who listened to him all the way down.
Any precedents? As quants, we are vulnerable to breaks in historical relationships and this is exactly what happened in Q2. Only once in the last 30 years (in Q2/95) have we seen crude oil plunging in Q2 despite significant inventory draws. In fact, the decoupling in Q2 is more than a two-standard-deviation move. The regression line in Figure 5 shows that the 27M draw (5% decline) in inventories should have equated to a high double-digit increase in oil prices in Q2. Could the market see crude builds this summer?
This would be very unlikely given the recent relapse in oil prices. Figure 6 should remind investors that there is roughly a three-month lag between oil prices and US rig counts. As such, US Shale production should taper off this summer. Furthermore, the table at the bottom of Figure 5 shows that historically, crude inventory draws in Q2 tend to persist in H2. Looking at the last outlier in Q2/95, oil prices and TSX energy stocks rebounded 12.4% and 6.8%, respectively, in H2/95.
Other factors at work. It is hard to pinpoint THE factor behind the above disconnect. Many investors point to OPEC eventually losing its battle to US Shales, hence a persistent oil glut. However, not only is the extension of the OPEC/Non-OPEC production-cut agreement to March 2018 expected to balance world oil markets (Figure 2), but a further extension to December 2018 would likely be struck to guarantee balanced oil markets. Another explanation could be spec positioning. Entering Q2, the market was too optimistic with total net long positions (WTI + Brent) nearing ~400K contracts (Figure 7). Many of these long positions have now been liquidated to levels that matched prior interim oil-price bottoms.
On energy stocks, beyond weak oil prices, the craze for growth over value investing may explain the underperformance YTD. Despite growth being overvalued vs. value, and an abundance of earnings growers in 2017, investors (until this week) have kept pouring money in technology/growth stocks directly and indirectly through passive investing which is compounding growth outperformance. This is one parallel with the 1999 tech craze. But another important one is the decoupling between oil stocks’ relative EPS strength and relative price performance (Figure 8). Unfortunately, history shows that a market correction may be needed to change leadership. The correction in 2000 handsomely rewarded value and energy stocks. For this and all of the above, we are sticking to our energy OW where we believe massive short positions in Canadian oil stocks (Figure 9) represent pent-up buying power for the next time up.
And there is your trading term du jour: "pent-up buying power for the next time up."
Quants, or rather their trading models such as this one, as a reminder, are taking over for flesh-and-bones investors. The above should serve as a preview of what happens to all other asset classes once things finally "break" relative to historical relationships.