The US led markets higher in December. The S&P 500 bounced more than 4% as Trump’s tax plan is closer to passing. Hopes are anchored on the belief that US companies will distribute tax savings to employees in the form of wage growth while also pumping cash back into the economy through capital expenditures. This theory of Trickle-Down Economics is often attributed to former President, Ronald Reagan, but many leaders from Bush to Trump have promoted the strategy. The concept is logical in a vacuum, but, the primary beneficiaries are the wealthy – not the working men and women who voted for Trump. Moreover, the lower and middle class will feel the pinch from the increasing national debt and the instability of entitlement programs such as Social Security and Medicare. Further, it is tough to argue that the scheduled tax cuts will have a better impact on wealth distribution when S&P500 companies have already spent $932 billion on buybacks and dividends in the past 12 months.
Commodities had an interesting month. WTI oil was up 3.4% as OPEC agreed to extend supply cuts another year to the end of 2018. The supply/demand dynamic will be something to watch closely, as consistent inventory draws in the US were offset by large inventory builds of gasoline. Gold was weak during the period, down 2.4%, while industrial metals suffered. Copper dropped another 4.5% to extend its fall to 11% since September. Some of the weakness can be attributed to China. A soft purchasing managers’ index reading and the decision by the People’s Bank of China to raise interest rates created nervousness about growth prospects. We should note that it is incredibly difficult for China to satisfy markets. Constant expectations of large-scale growth must be balanced against fears of the debt bubble bursting. However, we don’ believe the PBOC is losing much sleep over market acceptance.
The recent divergence between West Texas Intermediate (WTI) oil and Western Canadian Select (WCS) was addressed in November’s commentary and the one-year chart below highlights the degree to which the two have moved. The current $24 differential is beyond two standard deviations from the average over the past three years. While we focused on Transcanada’s Keystone pipeline spill as a primary contributor to the supply glut, compounding the pipeline issue has been a slew of new supply. Oil is being pumped from projects started when the commodity traded above $100. As such, output is forecasted to increase by 315,000 barrels per day (bpd) in 2018 and 180,000 bpd in 2019 to 3.2 million bpd. The surplus may not abate quickly either, as analysts forecast the issue could persist beyond 2019. Longer-term, underperformance from shale producers or an absence of financing, could severely impact oil supply from south of the border. Equity financing for the US E&P industry has slumped this year. The debt market has been robust, though, as the number of rigs drilling the horizontal wells used for shale oil production has more than doubled since May. Accordingly, through early 2018, Canadian producers may be punished from the shorter-term impact of overabundant supply – but, they will be well-positioned to benefit from a longer-term downturn in shale production.