EQUITIES COMMENT: "One Bad Apple" - Will it Spoil the Bunch?
TSX--Apple of My Eye during Q2 The energy sector powered ahead 15% during the second quarter and fueled a gain of 6.8% in the TSX Composite, one of the best performing markets in the world. Oil prices surpassed $70 per barrel due to a continued increase in demand resulting from strong global economic growth. On the supply side, numerous developments have created concerns production will fall short of demand:
The U.S. reinstated sanctions on Iran which produces about 1.5 million barrels of oil a day.
Supplies from Venezuela are shrinking due to turmoil in that country.
U.S. shale producers are now running into pipeline constraints so production gains have slowed.
An outage at Syncrude has further dampened the supply picture.
At the June meeting, OPEC and non-OPEC producers agreed to increase production by 1 million barrels a day. That may not be enough to keep prices from rising further.
Canadian producers are finally benefiting from higher oil prices as the Keystone pipeline is now operating at capacity after a partial shutdown this winter. Approval of Enbridge’s Line 3R and the federal government’s decision to take over the Kinder Morgan pipeline expansion should eventually reduce the transportation bottlenecks that have been hampering the industry.
A Whole Bunch of Good Apples…
Global economic growth is forecast to expand 3.9% in 2018 which is the best year since2010.
Inflation remains in check although $70 oil will likely cause some upward pressure.
Corporate profits are expanding faster than expected.
While some central banks are reducing monetary stimulus, interest rates still remain at low levels.
Government spending has increased in the U.S. and Canada; China and Europe could follow.
The threat of a North Korean nuclear attack has diminished.
Higher commodity prices, particularly oil, are benefiting large emerging economies like Brazil and Russia.
One Bad Apple....
Of course we are referring to Trump/Trade/Tariffs. The average U.S. tariff is 3.5%, one of the lowest in the G20. As we wrote last time, tariffs are negative for economic growth, inflation and corporate profits. A few billion dollars of tariffs will not have a significant effect on the global economy but selected industries will be pressured. Hundreds of billions will have a more pronounced negative impact. Estimates vary and there are many factors to consider such as the ripple effects on confidence and spending. We believe the probability of a full blown trade war has increased however, due to the economic damage it would cause, we do not believe it is the most likely outcome. If the trade battle does continue to escalate, we expect the Federal Reserve and Bank of Canada will refrain from further rate increases and possibly even reduce rates.
Outlook for the TSX - Will More Tariffs Upset the Apple cart?
Our twelve month target for the TSX remains unchanged at 17,000 supported by powerful earnings growth and assuming higher bond yields—two important factors in determining fair value.
The primary risk to reaching this level within the next year is the value of additional tariffs that are implemented.