The Lowdown on Markets to 12th December 2014
In this week’s issue
- The continuous fall in the price of crude oil spooks the markets and its investors.
- Clearly there are serious ramifications for those that import and export crude oil.
- In the Eurozone there is a clear disappointment in the take-up of the ECB’s TLTRO.
- Prime Minister Shinzo Abe wins the General Election in Japan.
- The CBOE Vix Index rises by 60 per cent over 5 days as volatility rises on uncertainty.
- The fall in the crude oil price should propel corporate earnings over the coming 12 months.
What does this mean for the markets and asset classes?
“The collapse in the price of crude oil unnerves markets and investors”
The continued fall in oil prices is setting the scene in this year’s run up Christmas and the New Year, indeed, with just one more full week left in the 2014 calendar the traditional Santa Claus Rally seems to be rather absent this year?, surely, the “doom and gloom” that is currently haunting the markets over oil concerns has left many of them oversold.
Clearly, the recent collapse in the oil price is an unusual event during what is being heralded as an expansionary phase in the global economy, with the world’s largest economy, the United States, leading the way. Indeed, the last time oil prices fell as much as they have done recently was in the aftershock of the Asian crisis back in 1998.
Unquestionably, falling demand is a clear factor with regions such as China shifting from an export-based, to a domestic demand based economy. This transition in the world’s second largest economy is not only affecting oil demand but also other commodities such as copper and iron ore that have seen their prices fall this year by 12 and 48 per cent respectively. Indeed the wider S&P GSCI [spot] Index is also down nearly 30 per cent since the beginning of the year.
Whilst the demand for “black gold” has certainly dried up over the past few months there has been a glut of supply which is undoubtedly a more important factor for a weakening oil price. Clearly, the “shale gas revolution” in the US has begun to transform the energy landscape, given that they will become the biggest oil producers in the world by 2019, having already increased their output by 70 per cent in the past seven years.
Interestingly enough, it would appear that Saudi Arabia, currently the world’s largest oil producer, has allowed the oil price to fall to try and put pressure on its US shale adversaries, given that they need higher oil prices to pay for development costs. At the same time the Saudi’s must be suffering from lower prices, given it is below their breakeven point, and therefore, pushing their budget into deficit. While they could tolerate the price being lower for a period of time the other regions such as Russia, Iran, and Venezuela must be truly hurting.
Whilst the sharp correction in crude oil prices is deemed to be an “ill wind” for the oil exporters, it is not so for the importers, or consumer related sectors such as transportation. Clearly, this does drive a divide between those regions that suffer and those that benefit. In terms of countries such as India and Indonesia the benefits from lower oil prices will help them at a time when structural reforms are being implemented by newly elected governments. Likewise, the Philippines, Malaysia, Taiwan and Korea should also be beneficiaries from being net importers of oil. Obviously, the worst effected region has been Russia given they are the world’s second largest energy exporter, and are suffering from the recent western sanctions over the Ukraine. Also the collapse of the Russian rouble has now led to the country’s central bank to raise interest rates to 10.5 per cent in an attempt to defend the weakened currency. Equally, Germany could now be affected by the actions taken in Moscow given their heavy investment programme in Russia; likewise, in Britain companies such as BP might be hit given its minority stake in Rosneft. In terms of the investment world this unforeseen fall in the price of crude oil has a huge implication for the global economy, individual regions, sectors, the consumer, and more notably corporate profits.
Clearly, oil has become far less critical to the developed world than it was in the seventies, however, cheaper oil prices is a major beneficiary for many businesses such as the airline industry, where spot jet fuel prices have already fallen by over 15 per cent since September. Another sector to benefit is the auto industry, given that governments are resolute to seeing auto manufactures produce better fuel efficient cars and light trucks, and of course the consumer, given that the fall in price is like an unexpected tax cut for many households meaning that people will have more money in their pockets to buy higher ticket items.
Unquestionably, in the corporate world a plentiful supply of oil, at much lower prices, should have positive ramifications for corporate earnings over the coming months, unless of course you’re in the oil business. This in turn, should help the markets in 2015, equally, the perma bears might say that the fall in the oil price, a slowdown in demand, and a stronger dollar is an indication that the global economy is deteriorating.
Arguably, quantitative easing, and loose monetary policy, has produced an asset bubble in equities and a bond, which in turn, has led to some central bankers treading warily over the timing of tighter monetary policies, equally, the unforeseen transfer of consumer income, from the sharp fall in crude oil prices, might help them with this crucial decision, none-the-less, the recent backdrop of weaker global growth data is likely to prevent the Fed from taking action any time soon.
Equally, the Federal Reserve Bank will be delivering its final monetary policy decision of the year on Wednesday, and whilst we are not expecting any shocks, some analysts are suggesting that the Fed will start to prepare the market for a period of tighter monetary policy by mid-2015.
In the Eurozone the announcement of a disappointing take-up to the ECB’s “Targeted Long Term Refinancing Operation” [TLTRO], loans to the banks, will probably force the central bank into a “full blown” sovereign bond QE programme sometime in the first quarter of 2015. Plainly, the region is suffering again from sluggish growth and a further fall in inflation; therefore, the European Central Bank seems to be fast running out of options.
In Japan, Prime Minister Shinzo Abe has won a new term in office after surprising the Japanese people by calling for a snap General Election. On Sunday the Japanese media reported that Mr Abe’s Liberal Democratic Party [LDP] had won the election retaining its House of Representatives majority.
The question will now be “how will Mr Abe use his new term in office” as he has already stated that he is determined to push ahead with difficult and potentially unpopular reforms.
It would now seem that the equity markets, and its investors, have become rather nervous over the past few weeks, with the CBOE Vix Index, universally known as “Wall Street’s fear gauge”, rising by over 60 per cent over the past five trading days with the collapse of the crude oil price depressing investor sentiment.
Admittedly, there is still a worry that the global economy might contract rather than continue on its path to recovery, yet, US data remains robust, and whilst the oil price has fallen by more than 40 per cent it should act as a tailwind going forward for corporates and consumers. Undoubtedly, we will experience further volatility and frustrations as we go through 2015 but like in previous years global markets will once again definitely pitch up with some interesting investment opportunities.
Chief Investment Officer
Peter Lowman has been in investment management for over forty years and prior to becoming Chief Investment Officer for Investment Quorum he worked within larger asset managers, primarily as an Investment Director within Cazenove’s. He is responsible for the overall investment strategy for Investment Quorum clients and sits on the Investment Quorum Investment Committee.
This article does not constitute specific advice and investors should bear in mind that capital invested is not guaranteed.
Investment Quorum is authorised and regulated by the Financial Conduct Authority.