Saturday, January 31, 2015

Lower oil prices: good news or bad?

The past months have been marked by weaker oil prices, with the WTI breaking below $44/barrel, and now sitting below a record 5-year low. With the lack of agreement among OPEC members to cut output, and subdued demand in a low potential growth environment, investors should probably factor in durably lower oil prices than they have been used to over the past 3 years. Is this good news or bad news?

Let’s consider the largest consumer in the world: the US economy. Although lower oil prices have historically been generally positive, not all periods of falling oil prices have led to an accelerating economy. Indeed, while lower prices coming from rising supply with resilient demand are good, declining demand is worrying. So, which is it today? Despite a small seasonal down-tick in world demand in October, rising supply has clearly been the prevailing factor driving prices down over the past few months. As long as this is the case, lower oil prices are positive for energy consumers. As to the U.S. industrial sectors exposed to capital equipment, a slowdown may be on the way since oil companies will inevitably reduce capital expenditures.

What about the rest of the world? Who are the winners, who are the losers? Net oil exporters will obviously suffer, while net oil importers will benefit.Not surprisingly, the Middle East will be the largest loser, although the region is immunized by its large fiscal surpluses. The situation in Russia is far more problematic, and the collapse in oil prices will certainly accelerate the country’s fall into recession. That said, the majority of the world economies are net oil importers/consumers and will therefore benefit from the slump in oil prices. As such, a further step towards discerning the prime winners is to look at the share of energy in their consumer price indices: the larger, the better. Turkey should also welcome lower oil prices as a means to reduce its large current account deficit and to better control inflationary pressures. Finally, Eastern Europe (Poland, Hungary, Czech Republic) as well as some core European countries (Spain, Germany) will get a nice boost from cheaper oil.

So, all considered, lower oil prices are a net positive for the global World economy. What opportunities on the investment side? Lower energy prices support consumers’ purchasing power. In the US, periods of negative oil returns have historically been associated with periods of out-performance of the MSCI Consumer Discretionary and Staples equity indices over the MSCI US equity index. An exposure to the US Consumer therefore appears to be a direct way to benefit from lower oil prices in USD.

Saturday, January 24, 2015

Markets at a Glance, January 2015

With U.S. consumer confidence reaching 11-year high in January the consensus is pointing to an estimated 3% GDP growth in the US, with a possibility that for the 1st time in many years US economy will contribute more to global growth than China.

We believe more volatility should be expected in 2015 as the Fed begins to normalize rates. This has several ramifications for capital markets and investment portfolios. Low oil prices and higher rates may impact industrial and energy sector capex.

Many commentators blame current market turbulence on the plunging oil price. We believe it is more about lingering geopolitical issues and a pending Federal Reserve (Fed) rate hike. 

First, we expect volatility to be elevated compared to the levels witnessed from 2012 to 2014. 

Second, we continue endorsing tactical stand within fixed income. Two- to five-year bonds are likely to prove the most vulnerable to higher rates. 

Although volatile, equity markets are expected to perform, although marginally, positive, benefited by the stronger dollar and growing US economy. 

Since we are cautious about downside risks in the equity markets we endorse measured and disciplined execution of equity strategies within portfolios.