Sound Bites: Oil enters a bear market after a mixed verdict on Japanese stimulus (Update)

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Updates number of mining stocks to 30 from 31 in third paragraph, adds that they are in the Basic Materials sector.

Japanese bonds and oil are shaky, should we worry? On Friday, Business Insider noted that oil had slipped into a bear market after falling 20% from its recent peak of just over US$51 per barrel. The move happened on the same day the Bank of Japan decided not to increase its bond purchases which dampened hopes for helicopter easing. While the two developments may not be directly related, falling oil and Japanese policy maneuvers both have implications for investors.

As I highlighted on Roundhouse Radio on July 14th, US oil & gas insider sentiment was collapsing. While we are not surprised to see the oil price subsequently retrace some of its gains, we are amazed at the speed of the decline early in the week. Oil prices managed a sharp comeback on Tuesday. However, that may be little more than short covering.

Investors are likely to be disappointed in the Energy sector for some time based on our INK Edge outlook rankings which equally considers valuations, insider commitment, and price momentum. In our recently published August INK Edge Top 40, oil and gas stocks were essentially missing in action. While there were 30 mining stocks from the Basic Materials sector on the list, only one oil & gas stock (North American Energy Partners NOA) made it. All told, Energy stocks made up only 2.5% of our August Top 40 list.

Our Top 40 represents our "best ideas" for the month. With Energy stocks remaining an "also ran" to mining in our Top 40 list allocation, we believe this signals that investors can be patient when it comes to deploying new cash to the group. There is still time to do some bargain hunting in the oil patch. For those who are interested, the latest INK Edge Top 40 can be purchased via the store (it is also included in a subscription to INK's CIA Interactive).

Oil moved into bear market territory even as the Bank of Japan announced more monetary easing. However, in a bit of a surprise, the easing came in the form of additional stock market ETF purchases, not additional bond purchases. Nevertheless, Japanese government bonds sold off even as the yen rallied, sending a mixed message on the implications of the policy. 

The bond selling and yen buying continued even after Shinzo Abe announced a long-awaited stimulus plan on Tuesday, which in terms of size disappointed some market participants. As the Wall Street Journal reported, the plan's direct spending is US$73 billion, most of which will happen over the next two years. Some investors had expected as much as double the amount. Spending will be spread between infrastructure spending, one-time transfers to lower income earners, and other areas such as child care.

For global investors, the response of the bond and currency markets is a bit of a surprise. Expectations were that if bonds sold off, the yen would also weaken. Instead, the strengthening yen suggests that investors may be relieved that the Bank of Japan did not increase its bond buying which could potentially lead to very high inflation. Meanwhile, bond investors seem to sense that the package could boost growth just enough to lift the economy out of its funk. If this is correct, Japanese policymakers may have accomplished a bit of a balancing act, by retaining a stable currency while pushing up long-term rates. Higher long-term rates will help its banking sector while a stable yen could boost corporate confidence with respect to investment planning.

Higher long-term rates on the back of improving growth prospects and stable foreign exchange would be a welcome development not only Japan, but in many developed countries including Canada.

Listen to Ted Dixon on Roundhouse Radio FM 98.3 every Thursday for his weekly financial markets commentary at 7:30 am Pacific Time. If you missed the live broadcast, catch the replay here.

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