The global equity markets have been in distress for the first month of the year. The TSX is down marginally, 1.9% at time of writing. The S&P is down 8.0% in the same period. There is a reason for this, which you will see.
David Rosenberg of Gluskin Sheff summed up the current thinking aptly in the Globe this week. “There seems to be a tight positive correlation now between oil and the stock market whereas in the past the relationship was inverse.” In the past, lower oil prices were considered a bullish factor for equities which makes sense if you were to think that lower input costs would add to the bottom line. This relationship has now reversed.
Why? At last count there were seven oil dependent countries that control almost $4 trillion(U.S.) of assets. 54% of the global tally. These oil producers then channelled their petrodollars across the worlds equity markets during the bull run in oil. Diversification was and is always a good thing.
BUT, with too much world supply, $120 oil has become $30 oil. Saudi Arabia as an example has a breakeven cost of $96 per barrel. Couple that with the fact that 90% of the countries revenue comes from oil and 60% of the population works for the government puts them in a real bind. Solution? Start selling other stuff you own to pay the bills i.e. equities. Many governments in the Gulf region as well as Africa, Asia and even Norway have been compelled to draw down reserves to cover their gaping fiscal deficits. Makes sense. This is the reason that the world’s largest equity market, the U.S. is down even more that ours here in Canada.
What next then?
For sage advice we look to our friends at Barron’s who seem to have a particular knack for predicting the price of oil. They are suggesting a short term drop to $20 followed by a resurgence to $55 by year end. You can’t make this stuff up. They quote:
“Oil bulls, take heart. The last leg of the bear market that began in mid-2014 is probably in sight, as marginal producers fall by the wayside. Supply cutbacks should bring a rebound in the price of crude by the second half of 2016.
But before a rebound, West Texas Intermediate crude will likely continue to fall, perhaps as low as $20 a barrel, before vaulting to the mid-$50s by year end.
Stock market investors can also take heart. The stock indexes have been closely correlated with oil of late, moving up or (mostly) down, as the price of crude has gyrated.”
Bad news always presents opportunity. One we are considering is to reduce our U.S. equity positions to create cash for a move into oil sometime around April. (see chart). The other nice thing is, as goes the price of oil, so goes the lowly Loonie. With the rebound in oil a potential upswing in our dollar to make the snowbirds, and us, happy.