How oil and other factors are weighing on markets

Concerns about slowing global growth are weighing on commodity markets, with oil prices declining 14% since the end of October, notes a weekly TD economics report. That drop isn’t helping a lagging TSX, and, if oil weakness persists or deepens, various economic variables will be affected heading into 2019.

The TSX’s overall composition is part of its underperformance problem, with a relative lack of tech and consumer discretionary stocks, as well as a greater tilt in energy, says a weekly financial digest report from BMO.

“Energy is still 18% of the TSX versus 5% in the S&P 500,” the report says. As a result, the TSX has posted a less than 3% annualized gain over the past five years versus nearly 10% for the S&P 500.

For 2019, BMO expects the U.S.-Canada oil differential to narrow, but the bank still expects the differential to be “historically wide” next year, in part because of a “staggering” lack of Canadian pipeline capacity.

Looking at other economic variables, a continuing dive in oil prices would likely reverse recent increases in headline inflation, diverging from the central bank’s last monetary policy statement (October), which was upbeat about an economy at potential and inflation on target.

“The softness in the broader oil market is likely a bit more concerning for the [Bank of Canada], as the weakness cannot as easily be explained as transitory,” says the BMO report, adding that weak oil prices lower the odds of a December interest rate hike by the central bank, and introduce doubt for a January one.

“It’s going to be much more difficult for the BoC to sound as upbeat in December if oil prices don’t at least stabilize,” says the report.

It adds that lower inflation expectations should support longer-term yields. “Look for the bond market to take its cue from the BoC’s tone in coming weeks,” it says.

On the loonie, the report notes the run-up in oil prices to the third quarter failed to support the currency, so there’s no compelling reason to think the loonie will be hit hard by the move downward. Still, BMO remains “cautious” on the Canadian dollar, looking at $1.32 relative to the U.S. dollar at year-end, and with modest appreciation in 2019.

Outside Canada’s oil producing provinces—Alberta, Saskatchewan and Newfoundland—economic impacts from oil should be minimal unless the oil downturn runs deep enough to slow central bank tightening and weaken the loonie more significantly, says the report.

Going forward, global growth concerns could be particularly worrisome for oil demand and prices if slowdowns come from China and the U.S., since these countries are more energy intensive, says a weekly CIBC report.

Factors to watch beyond oil weakness

Fading U.S. growth tops the list of factors that investors might want to focus on in the next six to eight months, says a weekly market report by Robert Kavcic, BMO senior economist. BMO’s forecast for U.S. growth is 2.9% in 2018, 2.5% in 2019 and 1.7% in 2020.

Earnings growth is also slowing, settling in to single digits. “Hardly bad, but it’s not 20% growth anymore,” says Kavcic in the report.

And, as U.S. import tariffs become fully felt, the CIBC report notes that some U.S. producers will be affected more than others. “Look for electronics producers to see less of an impact on bottom lines than their import-intensive auto and primary metal counterparts,” it says.

Another factor for investors to consider is the now-over era of negative real interest rates, says Kavcic—which will soon become an era of below-neutral Fed policy rates.

None of these factors necessarily argues for the end of the bull market, he says, but rather a “resetting of expectations, as we often see throughout the cycle.”

For full details, read the reports from TD, BMO, CIBC and BMO’s Kavcic.