Market Outlook – Deja Vu?
“One Two Three Four/ If I had ever been here before/ I would probably know just what to do/ Don’t You?”- Déjà Vu, Crosby Stills and Nash
Geopolitical events continued to dominate headlines and investors’ concerns through the end of 2014 and into the New Year. In the Middle East, the rise of the Arab Spring continues to foster fears of contagion. Worsening economic conditions in Egypt, Iran’s nuclear ambitions and Syria’s obstructionist leadership all served to increase tensions. Despite sanctions, Russian leadership exhibits no intention to leave the Ukraine and may even be considering some interference in the Baltic region. Chinese policy appears to be more inwardly focused as attempts are made to bring more order to the banking system while fighting corruption on a massive scale. In the face of all these events, US policy appears to be weak and ineffective as they head towards another election year with an embattled political system in which agreement or consensus is unlikely.
As the Fourth Quarter progressed, economic concerns grew on a global scale. European economies continued to exhibit signs of stagnation and fears of deflation. Germany, the primary economic engine of Europe, reported slowing rates of production. The slower rate of growth in the Chinese economy continued to weigh on many commodity prices. Despite the apparent oversupply of oil, Saudi Arabia decided not to curtail production in order to support prices. This event caused crude oil prices to fall precipitously from near $100 per barrel to nearer $60 and had a major negative impact on markets with larger oil exposure, such as Canada. The US economy and market stood out as a refuge in this turmoil.
The collapse in oil prices has been particularly painful to the Russian economy where nearly 65% of their exports are related to oil and gas. The Energy Sector in the Toronto Stock Exchange fell 17% in the quarter. As we enter 2015, it is interesting to note:
- There is a financial crisis in Russia
- We are in a period of weak oil prices
- Investors have fled into US securities and treasuries resulting in a strong US dollar…
- While currencies in emerging markets are very weak
- The Japanese and German economies are exhibiting signs of slowdown…
- While the US economy stands out as the economy expands and employment improves
- The strongest sector globally was Technology (Hardware) in 2014, and,
- The democratic President of the United States is under siege from the Republican House and Senate
Market Outlook – Have we not seen this before? This looks a lot like 1998!
If the analogy was perfect perhaps we would know just what to do, but some things are a lot different. The emerging markets of the late 1990’s were the BRIC’s (Brazil, Russia, India and China) along with the Asian Tigers (Hong Kong, Singapore, South Korea and Taiwan). Today, China is a much bigger and more dominant player on the world stage. Also, many of the emerging economies of the late 1990’s had fixed exchange rates but are now facing the dilemma of having floating rates at a time when they are saddled with debt, much of it denominated in US dollars. Eventually, it was the collapse in the Technology Sector that brought down the markets in the early 2000’s, including the US market.
Weak oil prices may yet have a damaging effect on the US economy. Oil and gas production has soared over the last five years in the US as shale production has benefited from new techniques. The strength in the US dollar will affect their ability to export into weaker economies with less purchasing power. Many oil and gas companies have already announced cutbacks to dividends and capital expenditures in the face of uneconomic prices. These cutbacks will reverberate throughout the economy as illustrated early in 2015 as US Steel laid off 800 employees involved in the manufacture of pipe for the oil industry.
On the positive side, lower prices will put more money in consumers’ pockets. Lower prices should also spur demand while supply shrinks as companies cut back on programs. In other words, the energy markets remain cyclical. Where prices settle is anyone’s guess but we would surmise that ultimately prices have to reflect the marginal costs of production. $100 per barrel may well be too high in today’s world but $40 is likely too low. The strong, well-financed companies will survive and benefit from the opportunity to take advantage of acquisitions at low prices as the weaker companies fail.
As we enter 2015, a number of events will be on investors’ watch lists. The United Nations Climate Change Conference will be taking place in Paris where nations will be outlining their national goals for moderating carbon emissions. Two very important trade negotiations are also underway: the Trans-Atlantic Trade and Investor Partnership between the US and the European Union and the Trans-Pacific Partnership with the involvement of the US and China. Freeing up trade will spur global economic expansion to everyone’s benefit.
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