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June 27, 2024 | Total US Energy Stocks Rose 9.4 MB Last Week. WTI Crude Should Breach US$80/B in the Coming Days

Josef Schachter

As a 40 year veteran of the Canadian Investment Management Industry, Josef Schachter has experienced several exceptional and turbulent global economic and stock market cycles. With his primary focus on the Energy Sector, Josef is able to weave global political, economic and monetary issues with current energy data into a compelling story of what's going on in the sector, what is to come, and why.

Mixed economic data continues to sway markets from euphoria to concern as each data piece is scrutinized for signs of economic progress with declining inflation or signs of economic weakness and job layoffs with rising inflation.

Canada got a surprise on the inflation front on Tuesday with the core May CPI (month over month) which rose 0.6%, way above the forecast of up 0.3%. The headline rate was up 2.9% but the service sector increase was up 4.6%. This will keep the Bank Of Canada from cutting again in the near term.  The culprits for this increase were service sector components such as higher flight costs, rents and cell phone plans.

California’s implementation of higher minimum wages caused a sharp increase in unemployment as many businesses could not afford the higher wage costs and just closed. Nationally jobless claims are at 11% of the workforce and in California it is 20%. So with 20% unemployed in California the data suggests that that state may have entered recession in October of 2023.

Other data of note:

  • US Housing Defaults hit the highest level since 2011, 2006-2008 and the 2022 peak.
  • Costco is seeing weakening sales across its consumer base. Shopping for large quantity items is no longer attractive as family budgets are squeezed. If earnings slow this quarter and upcoming quarters keeping a 53x P/E multiple may be hard to do.
  • Japan’s Norinchukin bank (US$800B of assets) is in trouble and plans to sell US$63B of US debt that it holds. Its large derivative book is their trouble spot and they are working to keep the bank functioning. It is positioned in collateralized loan obligations (CLO’s). These loans are tied to corporate debt. The fear is that this will spread to other banks that hold this toxic instrument and the Lehman analogy is being used. When banks won’t trade with you as they fear your repayment may not occur or the collateral will not be sufficient then the house of cards occurs. The bank has already taken US$10B of losses on their CLO’s. Now they will take losses on their US bonds which have fallen in value as interest rates have risen over the last three years.
  • US Manufacturing has flatlined. This has dampened diesel usage.
  • The Treasury has a US$183B three tranche auction this week of 3’s, 5’s, and 7’s. We will be watching to see the success of this large funding and the rates needed to move the debt.
  • The US Leading Economic Index (LEI) has dropped 14.7% from the cycle peak. Such a drop has only been seen before recessions.
  • The Dallas Fed Manufacturing Index fell by 17 points to -15.4. This is the lowest reading since mid-2020 during the Covid collapse. A large trucking company filed for bankruptcy in Texas last week.
  • JPMorgan’s Jamie Dimon told an audience in Shanghai that persistent stagflation and inflation warned of a potential US “hard landing”.

Summarizing – The Fed is boxed in by their own policy mistakes. They kept saying in 2023 that inflation was transitory and we now know this as false. They also erred by prematurely calling a pivot in December 2023. If inflation persists and goes higher in the coming months, some FOMC voting members have indicated that they may want to raise rates. So the most likely case is ‘higher for longer’. Stagflation is here and consumers are spending less while still facing an onslaught of higher prices making household budgeting tighter. We may be in the early stage of a consumer recession which is nearly 70% of the US economy. Not a good situation during an election year.

On the wars front:

  • Lebanon’s Hezbollah backed by Iran has used more precise missiles against Israel’s north. It is now gearing up for war with Israel. The Hezbollah Red Beret Brigade has been training for an invasion of northern Israel. Israel is moving troops from Gaza to be rearmed and then sent to the north to prepare for any offensive on that border. The Israelis have warned that they would even attack Beirut if the war widened. They have intelligence that this airport is where Hezbollah has its major weapons storage.
  • Kuwait has ordered its citizens to leave Lebanon and other Arab countries are suggesting this as well. More and more evidence is surfacing that the next move by Iranian proxies will be from Lebanon with attacks planned for all of Israel that could overwhelm Israel’s IDF.
  • Hezbollah has shown drone footage of the Israeli naval base in Haifa showing Israel’s naval vessels and sensitive bases and factories. A warning to Israel of its capabilities. It has received advanced weapons (drones and missiles from Iran) and these weapons can hit all of Israel.
  • The US wants to restrain Israel from invading Lebanon and widening the war in the Middle East. Netanyahu has blasted President Biden and the White House has lashed back. The US has restricted sending 2,000 pound bunker busting bombs out of concern Israel is using them in Rafah and endangering civilians. The US has also slowed the delivery of other offensive weapons as a hammer against the Netanyahu government. This break in the relationship with Israel is due to Netanyahu not listening to US advice any longer but rather is meeting the more aggressive stance of his right wing coalition.
  • The US forecasted today that there may only be 50 living hostages in Gaza.
  • The Houthis have struck 12 vessels in May making this the second most active month for their attacks against shipping in the Gulf Of Aden and the Bab-el-Mandeb chokepoint. They even claim to have fired at a US navy carrier in the Red Sea. There was no damage or injuries aboard the carrier.
  • China has seen more naval challenges in the Spratly Islands against the Philippine navy. More saber rattling in this contested area that may have significant energy reserves. China is building the world’s largest nuclear arsenal increasing its stockpile from 410 to 500, according to the Stockholm International Peace Institute.
  • Ukraine will be getting more air defense missiles from the US to protect Kiev and Kharkiv. They are redirecting this aid from other allied countries. Such armaments are in high demand yet the manufacturing of these weapons is difficult due to supply chain and limits to the western defense industrial base.
  • Russia has added a new offensive weapon, an ultra-advanced intercontinental ballistic missile the S-500. Another warning to the US to not give more advanced weapons to Ukraine or send trainers into the country.
  • Russia is very annoyed that the US used its satellites to guide long range ATACMS missiles that hit Crimea last week. They blame the attack on the US which provided the targeting information.

Market Update:  We are watching the economic data carefully as it appears that consumers are getting tapped out and this could drag down the economy. The offset is the 6% US deficit and large war spending that are keeping some areas of the US, with hot economies.  The military industrial complex and areas where weaponry is built are strong economic centers these days.

China has throttled back crude imports as weak domestic demand and refinery margin pressure persists. So if the two largest energy consuming nations see weaker end user demand then crude prices could breach US$75/b once again and we may even see prices breach US$70/b in the coming weeks. This should set up the next low risk BUY window for energy stocks. 

Energy stocks peaked in early April as crude reached its high of US$87.67 on the mideast war potential to expand with direct fighting between Israel and Iran. Prices retreated to US$72.48/b in early June as no escalation occurred and global inventories grew. It recovered thereafter to US$82/b on optimism of a strong summer driving season. We continue to believe that the weekly EIA storage data will be key to the near term price action. If we see a breach of US$70/b then we should get another low risk BUY signal, the first since early February 2024. At that low risk entry point we added some new BUY recommendations. The run from early February was very rewarding and the ideas on our SER BUY List for the most part did very well.

We now see the general market and the energy sector as vulnerable. A correction is in its early stages and we expect the next low risk BUY signal to occur during Q4/24. The S&P/TSX Energy Index peaked at 308 in week two of April and has fallen to 279 today. Our downside target is below 240. The overbought condition in April can be confirmed from the S&P Energy Sector Bullish Percent Index which rose from 39% bullish in February 2024 to 91%. Recent weakness has pulled this Index down to 50% yesterday. Over 90% is an overbought reading. It should decline below 20% to give off an oversold level and a BUY window once again. We show a chart of this in our SER report coming out tomorrow for subscribers.

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June 27th, 2024

Posted In: Schachter's Eye On Energy

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