Stock Markets Could Gain Despite Big Oil's Pain

Posted by Michelle Howard December 1, 2014

Despite hundreds of billions of dollars wiped off energy company shares since June by the slide in oil prices to a five-year low, there are reasons to be cheerful about the likely future impact on global stock markets.

Cheaper oil is, after all, good for global growth. It puts more money in the pockets of consumers, companies and countries that buy commodities from abroad. If current prices hold through 2015, global GDP growth could rise by around 0.3 percentage points, or around $250 billion, according to Morgan Stanley (MS).

There are of course plenty of reminders around that the world economy is not in great shape: a decline in manufacturing growth across Asia and Europe in November was the latest evidence that the recovery may be grinding to a halt as central banks fight to stamp out fears of a deflationary spiral.

But investors are betting that the current oil price fall is on the "good" side of deflation, easing the bill for consumers and companies without putting off investment plans.

"This fall in oil is like a tax cut for the consumer," said Emmanuel Cau, an equity strategist at J.P.Morgan Chase, adding that the drop in crude to below $70 a barrel was more the product of a supply glut than a drop in global demand.

While inflation will likely be dragged down from already low levels, Cau said this was unlikely to spook consumers into delaying spending; central banks may err on the side of caution and avoid tightening monetary policy too soon, he added.

"We expect global activity, consumer activity and retail sales to be more positive over the next few months," he said.

History Lessons
The market reaction for now looks grim indeed: $248 billion in market value has been wiped off European energy companies' shares since June.

But history suggests that a sharp fall in oil prices tends to indicate a buying opportunity for stocks. Since 1985, global equities have gained on six of the 10 times that oil prices have fallen more than 30 percent, according to Citigroup research.

So while oil exporters like Russia and energy stocks worldwide are bearing the brunt of this year's sell-off, investors and analysts expect this to be more than offset by overall gains for transport, retail, consumer goods and other industries on U.S., Japanese and eurozone stock markets.

"On a longer-term horizon this is going to put extra money into the consumer's pocket...It should probably be supportive for equities as a whole," said Wouter Sturkenboom, senior investment strategist at Russell Investments, which has $275 billion in assets under management.

What might spoil the party is if 2014's oil-price drop turns out to be much more than an adjustment to oversupply.

The 2008 financial crisis and 2001 recession were two exceptions to the historical pattern where stock markets fell in tandem with oil prices as demand -- not just supply -- imploded.

Energy Companies Suffer
While some investors believe the economic recovery is still on track, especially in the U.S., others point to potentially painful knock-on effects from the energy sector, even if it only accounts for about 10 percent of the market capitalisation of top U.S. and Europe equity indexes.

After all, the quadrupling of oil prices between 2002 and 2012 led to a drilling boom; reeling that in may have consequences on economic growth and on credit markets, where U.S. shale-oil companies have been "aggressive borrowers" in recent years, according to Citi.

"The U.S. will benefit at a consumption level but face considerable headwinds on credit and a dire need for the bubble-like investments in shale to unwind," said Steen Jakobsen, Chief Investment Officer at Saxo Bank in Denmark.

As well as cutting investment, major oil companies are likely to have to increase borrowing to maintain their cherished dividend payouts.

For now though, investors remain broadly positive on the impact of oil's fall on global equities, especially if the corresponding drop in inflation helps central banks stick to the script of stepping up measures to spur growth.

"The drop in oil price was the best thing that could have happened," said Luca Paolini, chief strategist at Pictet. "It increases consumers' spending power and gives the (U.S.) Fed an excuse not to raise rates."