Energy services stocks appear destined to market perform for the foreseeable future.

E nergy services are not responding to the traditional catalysts that would normally spur a valuation expansion. Global monetary policy is hyper-reflationary, as measured by our global monetary policy barometer. Typically, energy services stocks have outperformed when liquidity conditions are flush.

So far, the relative share price ratio has only been able to manage a lateral move, despite emerging from deeply oversold conditions. Does this tepid performance represent a potential ‘catch-up’ opportunity, or is it reflective of a new paradigm?

Our U.S. Equity Strategy service is leaning toward the latter.

Excess slack is preventing the industry from generating enough pricing power to expand profit margins to a meaningful degree. The decline in the global oil & gas rig count has pushed our idle rig proxy below one, defined simply as the number of rigs as a share of the prior peak. This is consistent with modest excess capacity. Pricing power gains have been difficult to generate when this gauge is below one, and major declines have been associated with industry deflation.

The odds of a sustained reacceleration in the global rig count appear low. Non-OECD product demand has slipped and the growth in Chinese oil imports is close to nil. Total OECD oil supplies are rising on a growth rate basis, similar to the trend in total U.S. energy inventories. OPEC spare capacity is creeping back up as Saudi Arabia reins in production to try to defend Brent oil prices. The message is that the physical oil market appears to be well supplied at the moment.

Bottom Line: Downgrade the S&P energy services index to neutral, as there are few remaining catalysts to break the index out of its sideways funk.

The risk-reward trade-off our Protector Portfolio is no longer attractive.

Our Global Investment Strategy service recommended the “protector portfolio” in October 2009, when financial markets were extremely unstable and investor anxiety was running high. This portfolio consists of 50% in Treasury bonds, 25% in the U.S. dollar and 25% in gold. These three assets were chosen because they demonstrated low correlation not only among themselves but also with risk assets over the long term.

Clients should remember that since March 2009, a major headache for portfolio management has been high correlations among different asset classes.

The protector portfolio has clearly served its purpose of preserving wealth during volatile and dangerous times. For instance, since inception, it has delivered a more than 7% annual return with low price volatility. Importantly, it has had a very low correlation with stock prices.

But clients should now either substantially reduce their holdings of this portfolio or close the position outright. The gold bubble may be bursting and yields on Treasury bonds have already fallen to 1.7%. The risk-reward trade-off is no longer attractive. Most importantly, the key central banks have acted decisively in containing systemic risk, suggesting that they are offering de facto protections for risk-taking activity.

Bottom Line: Substantially reduce holdings of this protector portfolio.