By Christopher Whittall and Tommy Stubbington
This month's big fall in the price of oil should be good news
for much of the world's economy. But so far markets have been
telling a different story.
The MSCI Europe index has dropped 4% since early December, while
the S&P 500 index remains 1% lower over the same period despite
a rally Thursday after the Federal Reserve said it would be
"patient" before raising interest rates next year. Emerging-market
countries such as Turkey and India, which are large oil importers
and so should benefit from the price slump, have seen their
currencies fall sharply against the U.S. dollar.
Analysts remain confident that the 48% drop in the price of
Brent crude since its June peak of $115 a barrel is merely a case
of delayed gratification for the global economy. Consumers will
have more money in their pockets and companies outside of the
energy sector will benefit from lower costs. Credit Suisse
economists calculate this is equal to a $100 billion tax cut for
the U.S. economy alone.
But although the boon is substantial, it will take a while to
feed through to economic data. Meanwhile, the effect of investors
dumping stocks and bonds related to the energy sector has rippled
across financial markets.
"Markets will take the hit before economies get the benefit,"
said Ewen Cameron Watt, global chief investment strategist at
BlackRock Inc., the world's largest money manager, with $4.3
trillion of assets.
Oil exploration and production are costly activities, and U.S.
energy companies in particular haven't shied away from tapping
financial markets to raise cash.
Energy companies now account for 17% of U.S. high-yield and 12%
of investment-grade bonds. They also make up 9% of the MSCI
Emerging Markets index, and 8% of both the S&P 500 and MSCI
Europe stock indexes.
Stocks and bond markets consequently fell when oil first dipped
below $100 in September, with energy companies leading from the
front, before staging a rapid recovery the following month as oil
prices appeared to stabilize around $85. When oil's free fall
shifted up another gear in late November, once again it was
energy-related assets that led the downward lurch.
Master limited partnerships, publicly traded securities that
don't pay corporate income taxes, took a hammering. NGL Energy
Partners LP, an MLP, fell 31%.
High-yield bond funds slumped, experiencing $3.8 billion of
outflows last week, which amounts to 0.8% of assets under
management, according to Bank of America Merrill Lynch. The yield
on Barclays's U.S. Corporate High Yield Bond index rose to 7.3%
Tuesday--over a percentage point higher than at the start of the
month. Yields rise as prices fall.
Mark Haefele, global chief investment officer at UBS Wealth
Management, which oversees around $2 trillion of assets, believes
U.S. high-yield bond default rates could rise above 5.5%, from
around 2% currently, if WTI crude oil remains below $60 a barrel.
With WTI now at $58, he is reducing his exposure to the sector.
The heavy weighting of major oil companies such as BP PLC and
Royal Dutch Shell PLC have dragged down the UK's FTSE 100 index
2.7% so far this month, taking its year-to-date performance into
negative territory.
The rot even spread to emerging markets that are expected to
benefit from the oil-price slump. The Indian rupee dropped 2.7%
against the U.S. dollar over the first half of the month, while the
Turkish lira sank 7.2%.
"At what price does falling oil create more financial distress
than it produces economic benefits? That is the question markets
have been trying to focus on in the past couple of weeks," said
Toby Nangle, head of multi-asset investment at Threadneedle
Investments, which handles GBP93 billion ($145 billion) of
assets.
One problem is that the lower oil price is reinforcing the
possibility of a default by Russia, notes François Savary, who
oversees about $10 billion of assets as chief investment officer at
Swiss bank Reyl.
"That would have an impact on financial institutions and
economic activity in Europe, and it is making people nervous," he
said.
But despite the current skittishness, most analysts still
believe the impact of lower oil prices on the real economy will be
positive. In the U.S., for instance, the gain for consumers is
predicted to outweigh any loss in energy-related investment, which
was only around 1% of gross domestic product in 2013, according to
Morgan Stanley.
"At the global level we think a lower oil price is very good for
growth, although there are regional implications," said Ric
Deverell, head of global fixed income and economics research at
Credit Suisse. "The problem is the costs are upfront and the
benefits are more diffuse: Everyone saves $10 a week filling up
their car, while high-yield bonds in the U.S. get hit [more
immediately]."
Europe, as an oil importer, should benefit too. As a result, the
selloff in European stocks piqued the interest of some investors.
European equities should also get a leg-up if the European Central
Bank decides to make mass purchases of sovereign bonds next year to
ward off deflationary pressures, which lower oil prices will
exacerbate.
"Some investors see this as a good entry point--there is buy-in
for monetary policy having a very positive impact on European
stocks," said Stephane Mattatia, global head of the macro group at
Société Générale.
There are already signs of investors putting money to work.
Global stock markets rebounded in the latter half of the week
following the Fed's dovish statement Wednesday and the
stabilization of oil prices around $60. But Mr. Deverell for one
believes markets will have to get used to permanently lower oil
prices.
Write to Tommy Stubbington at tommy.stubbington@wsj.com
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