Strategy Dashboard:

THE ENERGY RALLY POWERS ON

Oct 29, 2021

Forstrong’s structurally negative view on fossil fuel energy-related asset classes has been well documented. To summarize, with mounting environmental concerns, sharply improving renewable energy economics and fiscal buy-in from major economies worldwide; the pivot away from fossil fuels is deeply entrenched. While peak oil demand is still a ways away (with widely divergent forecasts from industry analysts), renewables will continue to claim a growing share of global energy consumption (for a deeper dive, please see section 4 from our 2021 Super Trends Report).

These long-term headwinds cast a dark shadow over oil and gas investments. But dismissing the asset class as uninvestable would be ill-advised. For starters, large oil and gas companies are well aware of the challenges facing them and many will redirect capital outlays towards renewable assets; thus diversifying their respective businesses. But more importantly, fossil fuel energy sources still account for approximately 80% of the world’s energy supply (read: like it or not, the global economy still runs on oil, gas and coal). The feedback loop between energy prices, inflation and global growth remains of critical importance for asset allocators. “Traditional” energy investments thus remain an effective tool for expressing cyclical views.

It can be difficult to reconcile a constructive short-term view against a downbeat longer-term one. But tactical opportunities present themselves from time-to-time in all types of asset classes; market darlings, pariahs and everything in between. While oil and gas prices have already enjoyed a considerable rally from their 2020 lows (it is hard to believe that oil futures closed deeply in negative territory 18 months ago), there are a number of factors which should, at minimum, keep prices elevated.  

Given that energy demand is leveraged to global growth, our expectations of a multi-year expansionary environment provide a fertile macro backdrop for the energy sector. With economies swiftly increasing industrial capacity back towards pre-COVID levels, supply constraints have emerged in numerous places (for a broader analysis of the recent shortages in energy and beyond, please see our most recent Ask Forstrong publication). Years of under-investment following the shale revolution have made it challenging for producers to quickly ramp-up their operations. Per the chart below, oil and gas rig deployment has been unusually sluggish during the current upswing in oil prices. Accordingly, we expect supply and demand imbalances to persist longer than the market consensus currently expects.

There are a plethora of different options available to investors interested in implementing a tactical energy exposure. Oil and gas commodity futures, upstream, midstream and downstream energy equities and energy-centric country equities such as Norway and Russia (I would be remiss not to mention Canada here) are just a few of the notable alternatives. From a risk/reward perspective, we particularly like the prospects of companies in the oil services industry. Their revenues are directly impacted by changing levels of activity in the energy sector, and thus a narrowing of the aforementioned gap between active rigs and energy prices would be a significant boon. Putting our structural concerns aside for the time being, we have initiated exposure to oil services equities in balanced and growth-oriented strategies.

GLOBAL STRATEGY OVERVIEW

Cash

We maintain a negative outlook on the US dollar from a mid to long-term standpoint, as over-valuation, fiscal largesse, an eroding yield advantage and counter-cyclicality all weigh on the greenback. However, last quarter we felt that a sharp rally in the Canadian dollar had pushed the loonie above fair value (versus USD) and tactically unhedged all US dollar exposure in our strategies. With the Canadian dollar rally sharply reversing course during the quarter, we have re-initiated a partial hedge on US dollar exposure in client portfolios.

Bonds

Fixed income markets are facing some notable headwinds with inflation proving stickier than many forecasters expected and major central banks soon to scale back asset purchases. With negative real yields prevalent in most developed market bonds and the potential for upwards pressure on interest rates, our view on fixed income remains downbeat. We have reduced fixed income exposure further below benchmark this quarter.

Equities

We expect a resumption in the “reflation trade” where asset classes with relatively high leverage to global growth outperform. More defensively-oriented exposures that were previously held to scale back equity risk are thus less attractive in our view. Accordingly, we have elected to take profits in US utilities sector equities and decrease exposure this quarter.

Opportunities

While maintaining a healthy skepticism towards the oil and gas sector from a longer-term standpoint, we believe there are tactical opportunities in the space at present. Companies in the oil services industry stand to benefit as an increasing rig count (from low levels) in the US and falling OPEC+ supply constraints provide a favourable backdrop for demand. We have initiated a position in oil services equities in balanced and growth-oriented strategies this quarter.

Gross-of-fees performance ($CAD) as of September 30, 2021. Returns for periods greater than 1 year are annualized.

Performance statistics for ETF Managed Portfolios are calculated from documented actual investment strategies as set by Forstrong’s Investment Committee and applied to its portfolios mandates, and are intended to provide an approximation of composite results for separately managed accounts. Actual performance of individual separate accounts may vary with average gross “composite” performance statistics presented here due to client-specific portfolio differences with respect to size, inflow/outflow history, and inception dates, as well as intra-day market volatilities versus daily closing prices. Performance numbers are net of total ETF expense ratios and custody fees, but before withholding taxes, transaction costs and other investment management and advisor fees. Past performance is no indication of future results. A rate of return for one year or less is not annualized.
Portrait of David Kletz, VP & Portfolio Manager of Forstrong Global.

David Kletz

Vice President, Portfolio Manager

View profile