11th February 2015
As Barings estimates that the fall in oil prices equates to a $200 billion increase in US consumer discretionary spending, Marino Valensise, head of the global multi asset group at the bank explains what this means for the economy and investors…
The precipitous fall in oil prices has largely been a factor of supply rather than demand, according to Baring Asset Management (“Barings”). Demand for oil has continued to grow year-on-year but supply has grown even faster. Slower-than-expected demand growth in China has only been a marginal factor: China represents around 12% of global oil demand, so weaker demand has not been enough to drive prices down by the dramatic 50% seen in the market.
Low oil prices are clearly supportive for industrial activity, with manufacturing and other industries across the globe benefitting from lower energy costs. The biggest beneficiaries of all, however, will be US consumers, who will enjoy an increase in disposable income of around $200 billion in 2015 due to cheaper prices at the pump.
Marino Valensise said: “Given the beneficial effect a lower oil price is likely to have on the US consumer, we have upgraded our views on consumer discretionary and consumer staples from underweight to neutral. Though it is not clear exactly how Americans will spend their extra cash, evidence suggests it is going into increased spending on food and restaurants; in Asia, consumer staples may be the beneficiaries. Though these sectors are not cheap, we still expect to see some positive earnings impact in the coming months.
“While we expect a similar phenomenon will occur in Europe, a combination of high taxes on petrol and a weak euro will dampen any positive impact on consumers in Europe. Similarly in Japan, a weakened yen will diminish any benefits from cheaper oil.”
A negative consequence of a lower oil price will be the hit to capital expenditure (capex) in the US. It is estimated that as much as 25% of capex in the US is linked to the energy sector. While there will continue to be maintenance capex in the sector, in Barings’ view there will be some reduction of spending from energy companies – which could eventually translate into US job losses.
Marino Valensise concludes: “We adopted a more positive stance on the energy sector in December when we upgraded our view from an underweight to a neutral position primarily because we believe there will be a pick-up in M&A. We also see that the large integrated oil companies have a variety of other business lines besides strict oil production which can act as a buffer against lower prices. Earnings have already been revised down significantly; however, it is not clear whether they have been revised down enough, which is why we remain neutral on energy companies rather than overweight.”
Overall, Barings believes 2015 will be a year of significant volatility and the beginning of interest rate rises in the US. The firm will continue to actively identify opportunities and pockets of growth in the global economy, as the consequences of major market moves become clearer.
A separate report by Moody’s today found that lower oil prices will not give a significant boost to global growth over the next two years, although it agreed that the US would benefit through “higher consumer and corporate spending”…
It said: “For the G20 economies, we expect GDP growth of just under 3% each year in 2015 and 2016.”
This was unchanged from 2014 and from its previous forecast, Moody’s said.
Marie Diron said: “Lower oil prices should, in principle, give a significant boost to global growth.
“However, a range of factors will offset the windfall income gains from cheaper energy.
“In the euro area, the fall in oil prices takes place in an unfavourable economic climate, with high unemployment, low or negative inflation and resurgent political uncertainty in some countries.”
Moody’s said the European Central Bank’s quantitative easing programme would give a slight boost to the eurozone by weakening the euro.
However, it said: “Weak demand in the euro area suggests that companies will have to pass on the lower energy costs, limiting the potential for higher profit margins.”