Decline in oil prices is a 'shot in the arm' for oil consuming economies, whilst dividends may also get a boost – but 'it's not all good news'
The Association of Investment Companies (AIC) has gauged the views of several investment company fund managers on the impact of the oil price declines.
Interestingly, Paul Niven, Manager, Foreign & Colonial Investment Trust thinks the oil price decline may have a positive impact on earnings, and a small positive impact on dividends, with other ‘high yielding’ areas likely to be “bid up” further from current levels as oil-related shares become increasingly risky.
Whilst Niven highlights that the risk to the US shale growth story could put wider US economic growth at risk, Andrew Bell, Chief Executive, Witan Investment Trust believes that the oil price falls are a “shot in the arm” for oil consuming economies – “despite the so far rather sulky response of equity markets”, whilst Stephen Macklow-Smith, Manager, JPMorgan European Investment Trust echoes this in the context of Europe. Macklow-Smith sees the oil price decline as “deeply beneficial because it amounts to a reduction in input costs and a dividend to consumers.”
John Lo, Portfolio Manager of Fidelity Asian Values PLC believes that the impact of the lower oil price is beneficial, but warns: “it’s not all good news, as this could result in increased volatility and geopolitical risk. The polarisation of performance between markets which are net importers of oil and those which are net exporters is likely to continue.” In this context, John Lo has "a strong preference for investing in emerging markets which are reforming (to develop stronger domestic demand) and which have a tailwind from weaker commodity prices. Generally Asian emerging markets such as China, India and Indonesia fall into this category.”
Paul Niven, Manager, Foreign & Colonial Investment Trust said: “I would expect the decline in oil price to have a positive impact on earnings, and a small positive impact on dividends. Global growth will be given a boost, inflation will be pushed lower and central bank policy may well remain more accommodative, with rate rise expectations getting pushed out even further in the near term. The reach for yield may extend further and, with oil related shares being amongst the higher yielders, but increasingly risky, other areas with yield may be bid up even further from current levels. The starting point is different, but it is worth remembering that the last two supply-led oil shocks, in ’87 and ’99, were followed by equity bubbles.
“However, based on historical experience, global energy earnings are set to decline by around a quarter to a third, and equity markets are hardly gushing in their enthusiasm for the decline in the oil price seen so far. First, markets are concerned that, with inflation low, the oil shock may tip economies into outright deflation with negative implications for consumption. Second, capital expenditure may be at risk in this scenario and has also been heavily boosted in the US by the shale story, which is at serious risk from here. Third, the labour market in the US, which has been very strong, has been significantly boosted by the shale states. If this is derailed then perhaps US growth is at risk. Another risk is contagion from the high yield market where energy issuance has been high.”
Why have markets reacted negatively to decline in oil price?
Andrew Bell, Chief Executive, Witan Investment Trust said: “The fall in the oil price is a shot in the arm for oil consuming economies, despite the so far rather sulky response of equity markets. Negative reactions have focused on three themes: that the speed of the fall creates a major shock for the oil producers, who will be forced to cut investment rapidly; this is true for that sector but there are more winners than losers in most economies. Secondly, that falling world demand is the possible cause so we should be worrying about recession; in our assessment increasing (shale) oil production has contributed more to the oversupply, even though demand has grown by less than forecast. So the lower price does not seem to be a forecast of recession as it was in 2008. And thirdly, that lower oil prices will push inflation rates lower or into negative territory, increasing worries about deflation. Lower inflation due to falling costs rather than collapsing growth counts as “good deflation” in our book. Reversing the argument, would higher oil prices accompanied by higher inflation rates really be better?
“Relative to where we were a few months ago the growth outlook has improved as a result of the halving in the oil price despite the equity markets’ grudging reaction to the windfall. The fall in oil prices is a major benefit for much of Asia (including Japan) which is a big importer of oil. Another key beneficiary is consumer spending beneficiaries in developed economies, where the reduction in unavoidable spending on fuel and energy will free up income for other uses. Finally, sectors which are highly energy intensive (such as cement or mining) and where hydrocarbon operating costs are significant (e.g. autos, trucks and transportation companies) will all enjoy some margin relief from such a large fall in prices, although it may take some months before analysts’ earnings estimates fully adjust. Selectivity is important, since other factors impinge on the different sectors and the world remains in a subdued growth phase that will not float all boats.”
Global Emerging Markets: why it’s important not to generalise
John Lo, Portfolio Manager of Fidelity Asian Values PLC said: “Overall, the impact of the lower oil price is beneficial. Consumers and companies the world over get cheaper transport, power, raw materials and heating. Countries that import oil have a huge benefit to their terms of trade, and also a fiscal benefit if they are subsidising oil prices to the consumer. However, it’s not all good news as this could result in increased volatility and geopolitical risk. The polarisation of performance between markets which are net importers of oil and those which are net exporters is likely to continue. There is a real need not to generalise about global emerging markets, but to distinguish between good ones and less good ones. I would have a strong preference for investing in emerging markets which are reforming (to develop stronger domestic demand) and which have a tailwind from weaker commodity prices. Generally Asian emerging markets such as China, India and Indonesia fall into this category.”
Positive for Europe
Stephen Macklow-Smith, Manager, JPMorgan European Investment Trust said: “The fall in the oil price recently has caused a lot of volatility in asset prices, but its impact on demand will be deeply beneficial because it amounts to a reduction in input costs and a dividend to consumers. We have seen that the headline rate of European inflation has dipped into negative territory but this is not the type of pernicious deflation that destroys confidence and encourages consumers to defer purchases, rather it alleviates pressure on real incomes. Falling oil prices help airlines and distribution companies by lowering input costs. They help automotives who benefit from the marginally lower cost of buying a car and cheaper fuel; they benefit a wide variety of consumer sectors such as retail that will see higher demand from consumers enjoying higher real incomes. It is true that the energy sector, including those companies who supply energy giants with capital equipment, will struggle. Certain countries such as Norway will also be negatively affected, but on balance this is a shot in the arm for the European economy which will help to heal confidence.”