Plunging oil prices spark global economy

Wealth managers are united in believing the sharp and sudden fall in oil prices – which have more than halved since their 2014 peak – will be good for most clients. 

However, working out precisely the how’s, what’s and when’s of the opportunities – as well as skirting round the various investment traps likely to open up– is much trickier. 

“We are entering a new era of cheap oil, so we should get used to low oil prices,” says Stéphanie de Torquat, investment strategist at Lombard Odier in Geneva. “It’s a game changer for the global economy and it’s good news.” On the other hand, “there will be collateral damage,” she adds ominously.

The new orthodoxy among private bankers is that prices could remain very low for a while. Even when they do stage a recovery, the new trading range will likely be much lower than the old one.

“No, no, no,” says Florent Brones, Paris-based chief investment officer at BNP Paribas Wealth Management, when asked whether the price per barrel of oil is likely to return to the $100 (€87)-plus level persisting before the 2014 price crash. “Oil prices will move up, but not to triple-digits,” he forecasts, citing the increase in global supply, including greatly expanded North American shale oil production.

The lower oil price will administer “a huge purchasing power injection” of 0.3 to 0.5 per cent of GDP this year to Europe, the US, China and other net oil importers, estimates Mr Brones. In response to this, BNP Paribas has upgraded its forecast for European economic growth, to an estimate of 1.2 per cent for 2015. 

Even before the sharp fall in oil prices, the bank was “advising clients to take the opportunity of any dip in the market to increase weightings in risky assets, such as the mature equity markets of Europe, the US and Japan,” recalls Mr Brones. However, “the fall in the oil price is accentuating this investment strategy,” he says, drawing attention to positive effect on economic growth and deflationary effect on prices, which in January forced the European Central Bank into quantitative easing. The combination of economic growth and QE has already pushed stock prices in the US up to record levels. 

But the weaker oil market will, naturally, not be good for all nations. “The decline in oil prices is positive for importing countries, and negative for exporters,” confirms Mr Brones. 

Wealth managers place Saudi Arabia, Venezuela and, in particular, Russia, among the losers, with Russia already suffering a currency and stockmarket crisis generated largely by this fall. However, Saudi Arabia is somewhat more cushioned because of its stronger fiscal position. 

Private bankers point out, however, that on the whole the global economy will benefit, because oil-consuming countries have a greater propensity to consume everything else too. They tend to spend rather than save – a proclivity that boosts gross domestic product. In addition, the bulk of investable assets are found in oil-consuming countries. 

Indeed many wealth managers see the fall in oil as part of a more general decline in commodity prices. This is often described as the end of the “commodity super cycle” of high prices, which prevailed for much of the 2000s. 

“There is lower appetite from commodity importers, including China, where there is a significant rebalancing of the economy,” says Xavier Denis, global strategist at Société Générale Private Banking in Hong Kong. “This will continue to drag commodity prices further down.” 

The Chinese government is making progress in changing the world’s second largest economy from a commodity-hungry investment-led model, based on building infrastructure and housing, to a consumption-led model. Investors see this as the greatest single cause of the fall in price of many commodities, including copper – which began its slide back in 2011, long before oil prices declined. 

A long-held view of long-term commodity price weakness has spared Société Générale from having to make abrupt adjustments to portfolios in response to the recent fall in the value of oil and other commodities. “For the past two years we have paid attention to the trend of declining commodity prices when considering asset allocation,” says Mr Denis. 

However, the bank is keen to highlight some opportunities which have yet to be fully priced in. Alan Mudie, head of investment strategy at Société Générale Private Banking in Geneva, notes the fall in US natural gas prices, which dropped in December below $3 per million British thermal units for the first time since 2012. The country’s gas prices have been hit by the expanding supply of shale gas. Mr Mudie says that, in the US, natural gas is much cheaper for heavy users, such as chemical companies, than in Europe or Japan – rendering US chemical stocks relatively more appealing. This, in turn, is likely to reduce US electricity prices – making US manufacturing stocks, such as machinery makers, more attractive.

His colleague Mr Denis wades into the debate about which oil-importing economy will benefit most from lower oil prices, by suggesting US consumers may respond especially acutely. He also downplays any effect on the eurozone – in contrast to French competitor BNP Paribas. 

“The US tends to be more sensitive to the oil price than the eurozone,” claims Mr Denis. “There are fewer substitutes for oil in the US, and the tax content of household energy bills is much smaller, making them more volatile for the consumer. The tax system is dampening down price movements in the eurozone.”  

In addition, Mr Denis believes households within the currency union are likely to save much of the price cut, rather than spending it. “When a large part of the eurozone economy is stuck in recession or very sluggish economic growth, the increase in propensity to consume, because of lower oil prices, is probably very small,” he estimates. “It will probably prop up spending in the eurozone less, for now, than in a more normal environment.” 

SocGen Private Banking therefore recommends an underweight position in eurozone equities. Japan will also gain heavily, says Mr Mudie, because of its heavy reliance on oil and gas imports – “quite a significant tailwind for the Japanese economic and current account balance”. SocGen was already strongly overweight in Japanese equities before the oil price fall, but the price decline “absolutely” reinforces the bank’s case for Japanese stocks. 

Yet good news for the US economy is not necessarily always good for the S&P, says JP Morgan Private Bank’s chief investment strategist for Emea, London-based Cesar Perez, drawing attention to the highly mixed effect of oil price falls on US stocks. 

“While oil investment is likely to slow, this is more than offset by the boon to consumers,” says Mr Perez. “The decline in gasoline prices represents a roughly $150bn tax cut for US consumers, and it’s already translating into stronger spending: the fourth quarter of 2014 marks an eight-year high for auto sales.” 

Leaving aside the boost to auto stocks, “the impact on corporate earnings is less obvious”. He notes disparity between energy’s role in the overall economy and its role in the stockmarket. Energy companies account for less than 1 per cent of total employment, but contribute 11 percent of S&P 500 earnings. As a result, net earnings impact on the S&P 500 from lower oil prices is only “marginally positive”, after balancing the higher spending induced by the fall in oil prices with the drag on energy company earnings.

By contrast, Mr Perez shows unalloyed optimism about the effect of cheap oil on the other side of the Atlantic. “The oil price decline is positive for consumers in Europe – not just in terms of lower costs for companies,” he says. “At a macro level it will feed into energy prices and ultimately the spending capacity of individuals.”

Wealth managers must also consider the awkward issue of timing. Several note that even if consumers eventually respond by spending some of their oil price gains, both energy companies and the capital goods makers that serve them are likely to react more rapidly. This presents a risk that stockmarket earnings as a whole could fall before they rise. 

The warning about timing is made forcefully by Keith Wade, chief economist and strategist at Schroders in London. In the medium term, “we see the falling oil price like a tax cut,” he says. It will, therefore, benefit consumer discretionary stocks, including big-ticket items such as autos. 

However, “the losers from a change in the oil price tend to react more quickly than the winners,” notes Mr Wade – whether for oil, energy-related industries or other assets. This has been manifest in the capital flight out of Russia and into Bunds and other safe-haven assets – pushing yields down on Bunds, in which Schroders is overweight. 

He explains that the winners –most notably the developed world’s consumers – have not reacted strongly yet to the fall in prices, because the gains are spread more thinly, even though the overall effect on global disposable income is high. As a result, stocks that would benefit from higher consumption have not raced ahead. “At the moment more adverse, disruptive effects are dominating sentiment,” he concludes.

For the biggest energy importers of the emerging world, stock price gains from falling oil prices could be even more delayed. “In India and China we need to be aware the benefits come through in a slightly different way,” says Mr Wade. “Their consumers enjoy subsidised oil and energy consumption, so the government is the main beneficiary of falls in oil prices.” 

Initially, these governments will reap benefits through lower outlays on subsidies – a phenomenon that could flatten sovereign bond yields by improving credit ratings. However, the improved fiscal position could generate an eventual tax cut, which would benefit the economy – and hence stocks – in general. It will, however, be a long and winding road. 

Low oil prices could also make the twisted path leading to eurozone monetary tightening even more extended and meandering than it appeared before. In January the route even started heading in the opposite direction, after the European Central Bank announced €1.14tn of quantitative easing. In Europe, cheap oil “strengthens the case” for an easy monetary policy, which supports equities, says Lombard Odier’s Ms de Torquat. 

“You could say that thanks to oil prices, we can be even more positive on European equities than we were before,” she concludes. 

Eurozone headline inflation turned into deflation in December for the first time in five years, with a year on year fall in consumer prices of 0.2 per cent. But though wealth managers agree the fall in oil prices will benefit European consumers, some see it as a double-edged sword. 

“The biggest global macro risk is deflation in Europe,” says Mr Brones of BNP Paribas. “That would be very, very painful and the decline in oil prices is increasing the probability of that scenario.”  

Crystal balls foggy as to future of fuel

While wealth managers are racking their brains to work out the likely effect of oil prices on a broad range of asset classes, they remain strikingly non-committal when it comes to the oil sector itself. This intriguing paradox applies both to direct commodity investment and to stocks and bonds. 

“We have not downgraded our equity exposure by so much,” says Xavier Denis, global strategist for Société Générale Private Banking in Hong Kong. “Oil stocks do provide attractive yields.” 

On the other hand, it is reluctant to hunt for bargains among the securities of shale oil players, which have been among those hit hardest by the fall in oil prices. “That would in our view be a speculation,” says his Geneva-based colleague Alan Mudie, head of investment strategy. 

Wealth managers’ reluctance to buy partly reflects a sense that there may be oily skeletons left in producers’ closets. Many shale oil producers that have issued bonds appear in a stable condition now – but Mr Denis says that might be because they have hedged for this year against falls in the oil price. By 2016 many of the hedges they took out when oil price were high will have ended. This could mean bond defaults not this year but next, he says.

Overall, SocGen Private Banking recommends a neutral position in oil and gas stocks. The reluctance to be strongly bullish or bearish on the oil sector also reflects a sense among wealth managers that they should not be in the business of coming up with firm price predictions in a highly unpredictable environment, beyond a general view that prices are unlikely to return more than momentarily to $100 a barrel for a very long time. 

“Today the oil sector is cheap from a quantitative point of view, and the dividends are high,” says Florent Brones, CIO of BNPP Wealth Management in Paris. BP’s dividend is 5.4 per cent, for example. “But are they secure? I’m not that confident about forecasting the oil price, so I don’t want to take bets to the upside or downside on oil stocks.” 

Some are even sceptical whether oil will return to a moderately stable equilibrium at all. “For a long time we had a trading range because the price was set by Opec countries,” says Stéphanie de Torquat, Geneva-based investment strategist at Lombard Odier. “Today the price is set by the US, Russia and Opec – and US production is not centralised, so the price will be set by the natural forces of supply and demand.” 

It will, in other words, be very hard to predict oil prices for the foreseeable future.