Equities could see a lift, but it’s bad news for oil exporters
Looking ahead to 2015, there’s plenty for markets to fret about. Rate hikes in the UK and US are a near certainty – after years of extraordinary monetary stimulus that propped up asset prices and kept sovereign bond yields low – as are continued worries over the fallout from an economic slowdown and possible “hard landing” in China. The Bank for International Settlements, meanwhile, known as the central bankers’ bank, yesterday issued a warning over the “growing fragility” of global markets, especially as an increasingly strong dollar makes dollar-denominated loans in emerging markets more expensive to repay.
But the falling price of oil is a relative bright spot for some. Yesterday, Brent crude hit a new five-year low of $66.47 per barrel, with forecasters predicting that an oversupply will last into next year after Opec decided not to cut output. Admittedly, many in the market think prices could be starting to bottom out – net-long positions on Brent crude jumped by almost 50 per cent last week as hedge funds sensed a turnaround in oil’s tumble – but few expect a dramatic reversal back towards the levels around $100 per barrel seen over the summer (see graph). Morgan Stanley, for example, became the latest banking giant to cut forecasts on Friday, slashing its predicted average Brent crude price for next year to $70 per barrel.
The growing consensus is that oil’s fall is a net positive for the global economy, affecting a transfer of wealth from oil producers to consumers that should have knock-on effects for disposable incomes and demand. Christine Lagarde, head of the International Monetary Fund, last week said that the Fund expects falling oil prices to add 0.8 percentage points to GDP growth for most advanced economies. How will this play out in financial markets?
THE MACRO PICTURE
Oil is expected to stay cheap throughout 2015, with Opec producers keeping the taps on and the US shale boom continuing. Some even see the cartel’s power to manipulate prices as permanently dented in a world where supply is rising faster than demand. As Saxo Bank’s Ole Hansen noted in City A.M. recently, “with demand for Opec’s oil next year more than 1m barrels below current production levels, individual members have responded by reducing prices to maintain market share.”
Disposable incomes in developed economies like the US, UK, Eurozone and Japan are likely to be boosted if prices do remain low, which could prove to be a boon for the stocks of large retailers in these economies. It’s estimated that a $40 fall in oil prices means a transfer of around $1.4 trillion (£896bn) from oil producers to consumers, and the latter group is far more likely to spend the money sooner. Capital Economics analyst Michael Pearce thinks the effects will be concentrated in the US, since taxes make up a smaller portion of overall fuel bills, and oil prices themselves haven’t fallen as far in euro, sterling, or yen terms.
He estimates that a $10 fall in the oil price saves consumers in major advanced economies $50bn a year on motor fuel bills, meaning that the $45 fall we’ve seen in recent months could free up around $225bn to be spent on other items because of lower petrol prices alone. Eric Lascelles of RBC Global Asset Management, meanwhile, says that energy-intensive manufacturers – especially car companies – will also see falling oil prices as a boon. Airline stocks too are seen as likely beneficiaries if prices continue to plunge, with the NYSE Arca Airline Index up by over 8 per cent in the past month, although analysts say it’s likely that a lot of the good news may be priced in by now.
MONETARY POLICY – STOCKS UP
Beyond helping retailers, manufacturing and airline stocks at the margin in the West, falling oil prices are also expected to provide a lift to equities in general, with disinflationary pressures allowing central banks to keep policy looser for longer.
In its latest Inflation Report, the Bank of England said that a stronger currency and falling fuel prices could see headline inflation fall below 1 per cent in the next five months. As Deloitte’s Ian Stewart pointed out in a note yesterday, it would be the first time this has happened since the Bank gained independence in 1997. And the theme is by no means limited to the UK. For economies, like Britain and the US, that are on a tightening cycle, oil’s fall could give central bankers extra breathing room. For the European Central Bank and the Bank of Japan, on the other hand, disinflation only increases the probability of more aggressive monetary stimulus next year.
But it’s not all good news for stocks. Markets hate geopolitical instability, and the oil price has a tendency to interact in all sorts of unpredictable and chaotic ways with events in oil-producing countries like Russia, Iraq, Iran, Venezuela and Nigeria. Simon Derrick of BNY Mellon has pointed out that the last three times Russia’s army crossed international borders (Crimea this year, Georgia in 2008 and Afghanistan in 1979) coincided with a peak in oil. Shortly afterwards, prices fell dramatically. It’s difficult to draw a clear lesson for markets, but Russia is nonetheless a vivid example of how sharp swings in commodity prices and geopolitical ructions never seem to be too far away from one another. The Economist’s Buttonwood columnist recently noted that the weakness of oil in the 1980s played a role in the downfall of the Soviet Union, and the rouble has lost almost 50 per cent of its value against the dollar this year.
But Russia is far from the only likely loser from a further fall in oil prices. Angus Campbell of FxPro says that the Norwegian krone has seen a 19 per cent fall against the US dollar since the summer, and this could continue. Lascelles argues that the most exposed currencies aren’t necessarily those of countries that produce the most oil – how much of it they export is likely to be more salient. In this vein, key Opec countries, as well as Russia, Norway, Canada and Mexico, could be vulnerable to further falls.
Obviously, individual oil-producing companies are also likely to suffer. Only yesterday, ConocoPhillips and BP were both reported to be taking steps to cut costs, whether through reducing capital expenditure or laying off more staff. But, as with airlines, many analysts say that oil’s fall could be priced in to energy stocks by now, so short-sellers should tread carefully.