The Collapse of Oil Prices: Threat or Chance?

05_Discoveries ---The prolonged slide in oil prices to early 2000s levels has, in our view, profound implications for the economic outlook and financial markets. In a recent Perspectives piece, I’ve addressed some of the key questions that the oil weakness has raised, with a specific focus on investment consequences. I’ve included some highlights from that piece in this post.

 

What are the forces driving oil?

The decline in oil prices is, in our view, mainly a consequence of a supply shock, but the lack of strength in global growth and the transition of China toward a more mature economic model has clearly contributed to widen the gap between supply and demand. If, as we believe, there will be a stabilization of supply/demand dynamics and the scenario of slowdown with no hard landing for China holds, we see oil prices gradually returning to 45-50 USD per barrel by the end of 2017.

Perspective Oil Chart 1

 

 

What is the impact on growth and inflation?

With this outlook for oil, the global economic outlook remains moderately positive. The main implication is lower inflation expectations, which will likely trigger a new wave of monetary policy intervention.

Who are the winners and losers in the oil price plunge?

In terms of winners and losers, we see a neutral impact on the US economy, with the benefit of higher disposable income almost counterbalanced by lower investments, and a slightly positive effect on the Eurozone. On Emerging Markets, lower oil prices (and lower commodity prices generally) increase the dichotomy between exporters and the importers who are enjoying the oil “dividend”. Financial markets have framed the slide in oil prices more as a demand-side shock (with negative effects), than a supply side shock. Since the beginning of the year, the correlation1 of all assets with oil has increased substantially and equity markets have traded very closely with oil prices.

What are the investment implications?

We believe that the recent market selloff has generated price dislocations that could offer interesting opportunities for investors. Yields have been pushed well above the 10-year average2 on the riskier segments of the credit market (particularly in US High Yield, where the energy component weighting is about 10%). Markets are incorporating an “Armageddon” outlook for the energy sector, which is not likely in our view. A re-rating of inflation expectations has hit inflation-related assets (i.e., bond linkers), and now discounts a very negative outlook. We believe that the market is underestimating the inflation pressures that could come from wage growth (in the US), and therefore we believe that opportunities may open up in the linkers segment.

To read more on Pioneer’s Perspectives page, please click here.

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1 The degree of association between two or more variables; in finance, it is the degree to which assets or asset class prices have moved in relation to one another. Correlation is expressed by a correlation coefficient that ranges from -1 (never move together) through 0 (absolutely independent) to 1 (always move together).

2 Source: Bloomberg, data as of February 22, 2016.

About Monica Defend

Monica Defend is the Head of Global Asset Allocation Research with Pioneer. Investments in Italy. She has been working in the investments industry since 1997. She is responsible for providing asset allocation recommendations and core. investment strategies at macro, sector and national level. The Global Asset Allocation Research team is responsible for the short, medium and long-term asset. class forecast; asset class valuation; the construction and implementation of trading rules and closely monitoring the financial markets. Monica moved to the Milan office as Head of Italian Quantitative Research. Prior to that, she was a Quantitative Analyst in the Dublin office. Monica has a degree in Social and Economics Sciences from Bocconi University. She also holds a Master’s degree in Economics from Bocconi University and Master’s degree in Financial Economics from London Business School-Bocconi. She has been a member of the Unicredit Management and Banking Academy since 2004.
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