Lower oil prices positive for global growth
The main macroeconomic consequence of lower oil prices as a result of over-supply is the positive impact on economic growth via the lower cost of consumption. Although, lower prices reduce incentives for capex in the energy sector (relevant for the US, where energy capex has been an important driver in the upward swing in investment witnessed since 2008), this negative influence has to be put against the positive impact on industries using energy as an input (such as airlines, consumer durables, etc.) and the household sector. Various studies estimate the positive global growth impact of the sharp fall in oil prices experienced over the last few months at around 0.5% to 0.7% per annum.
However, as we have discussed in previously, there are clear winners and losers both in the EM and DM worlds as a consequence of this shock. In our view, the DM world including the US (but with the exception of Norway), benefits from the positive growth effect, while the differentiation lines are quite sharp in EM. We believe that Asia ex Japan is likely to be a winner together with oil importers in CEEMEA (Hungary, Turkey and South Africa), while oil exporters such as Russia, Mexico and Brazil will lose out.
In recent weeks markets have identified this theme with clear relative performance patterns appearing along the oil exporter/importer lines. However, some market participants fear that the widespread damage to oil exporter/sensitive assets may turn out to be a more systemic issue with broad spill-over effects on global fundamentals and sentiment. We disagree.
How do shocks get magnified?
The first factor to consider when assessing a shock to the global economic/financial system is to understand its nature. As we discussed above, a supply-side induced reduction in oil prices is, at its core, a positive shock to economic growth. Secondly, as we saw in the subprime induced crisis of 2008, banks can play a very important role in transmitting the shock to the real economy. Here, understanding the size and distribution of the losses as a result of the likely defaults in the global energy production sector is key.
We have two additional observations. Firstly focusing on the US, despite significant growth the size of the energy sector hardly compares with the size of the housing market, which was at the core of the 2008 subprime crisis. Secondly, as noted in the case of countries, there are winners and losers in a big economy such as the US with the energy sector losing out while energy consumer-focused and household sectors will be the beneficiaries (more of a zero-sum game rather than an absolute fall in wealth).
As such, we think that the losses created by the fall in oil prices are unlikely to be magnified by the banking sector (as they will mainly impact energy equity and bond holders), and, at the same time, the global growth profile is likely to look materially better.
However, in the sovereign space, the sustained pressure on Russian assets resulting from the fall in oil prices is a genuine worry for global investor sentiment. We have already seen some significant measures taken by the Russian authorities to stem the pressure on the currency, while the geopolitical landscape involving Russia/Ukraine adds another layer of uncertainty. Here, our view is that a Putin-led administration is likely to ease its stance on eastern Ukraine given the downward shift in global oil prices (Russia’s major export). Any connected expectation of easing in sanctions should provide the necessary breathing space for the country, which has ample FX reserves and a relatively solid balance sheet (when compared to 1998 and its current peers).
Benchmark versus asset class
Given the re-distribution of wealth due to the sharp fall in oil prices (both at the country and sector level), we believe that the outlook for the underlying fundamentals (both sovereign and credit) will play a key role in identifying the winners versus the losers. This overarching observation creates a wedge between the definition of an asset class and its implementation. For instance, the energy sector makes up more than 15% of the US high yield universe, while it is only 5% for CDX high yield. Similarly, energy accounts for around 12% of the US investment grade universe, but just 6% for CDX. These exposure statistics show that when it comes to assessing the implications of the oil shock, it is critical to understand the make-up of the various indices representing an asset class as broad brush conclusions are likely to be very misleading.
