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Remember the commodity supercycle? While the world was getting high on incredibly loose credit between 2000 and 2009, commodity prices went absolutely bonkers. Thanks to a weakening dollar and aggressive Chinese demand, anything tangibly linked to digging things out of the ground seemed to go up, including the currencies of certain commodity-linked emerging market nations. One stat from that era for you: global M&A activity in mining and metals rose from around $10bn in 2002 to just over $150bn in 2007.
The past decade, however, has been a different story. Shale, a strong dollar, trade wars and falling Chinese consumption have — among other things — led prices to dip. Yet after the energy fallout from the Covid crisis — expressed most memorably in negative oil prices last April — are we due another cycle?
JPMorgan’s Marko Kolanovic seems to think so. In a note published Monday he outlined the reasons why energy prices, and related assets, might have turned.
The note is in the usual place, but we wanted to pick out one factor that Kolanovic and his team thought might contribute. Here’s the relevant paragraph:
Rotation by discretionary funds and retail: In the period from 2010 to 2015, the Energy sector had a 10.6% allocation in equity portfolios. This has steadily declined to a 3.1% weight currently (Figure 4). The largest decline was in active allocations, which declined from 7% to 1.5% (while passive allocations decreased from 3.6% to 1.8%). Any retracement of this decline, on a US equity fund asset base of ~$14T would result in significant inflows and re-pricing. As economies reopen, inflation moves higher, and yield curves steepen, active funds are expected to first close cyclical shorts, and then rotate from long secular growth towards value and cyclicals. Given that equity assets significantly increased over the past 10 years, and the energy sector significantly decreased, even a small rotation could produce an outsized move. Retail investors also reduced energy equity allocation from 4.4% to only 0.6% currently. Given the increased retail activity and interest in stocks that are volatile, have high short interest, are smaller in size and have thematic news/social media coverage (see here), the sector will probably also be of interest to retail investors.
And here’s Figure 4:
Convincing stuff. Although a counterargument here might be the fact that retail investors seem to have little interest in anything with a perceived negative effect on society — whether it be tobacco, defence or energy — at the moment. Conversely, ESG stocks keep going up. Not because the valuations are favourable, but just because they don’t want to own names like Shell, Altria or Lockheed Martin and express this through exclusionary ETFs, index funds and investment trusts. Will they abandon their principles to chase returns? Who knows. But, having talked to several young investors looking to make their first investments, it wouldn’t be the base case for us.
Thoughts welcome below, as always.
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