Stocks will slip up on cheap oil

Stockmarkets have come under pressure from the low price of oil, and there's no let up in sight.

The bears are still firmly in charge in the oil market. September 2015 marked the 11th monthly price decline in the last 15 months. A year ago, oil stood at around $100 a barrel. It is now around $48, having fallen back below $50 last week, and signs of a sustained upturn remain elusive.

Early this week, China reported falling industrial profits and the International Monetary Fund cut its target for global GDP growth for this year and next, due to slowing growth in emerging markets. "None of this is rosy for crude demand," says Daniel Holder of Schneider Electric. And while production has fallen slightly in America, Russia, Norway and Mexico, this hasn't been "enough to balance the supply glut".

Oil cartel Opec's output continued to rise between April and August, while Brazil has sped up its rate of oil extraction, says Nicole Friedman in The Wall Street Journal. Iran also claims it will be able to increase oil exports by 500,000 barrels a day by late November or early December.

Consulting firm Energy Aspects estimates that global crude stockpiles are at 80% of capacity, meaning that the supply glut could remain for some time to come. A strong dollar has also dented oil prices, as commodities are priced in the American currency. The upshot? Oil is set to trade between $40 and $50 a barrel for the rest of 2015, says Societe Generale.

Saudi Arabia under pressure

But to the Saudis' surprise, the shale industry has proved more resilient than expected many firms have been able to lower costs and maintain output. Plenty of shale drillers are heavily indebted and vulnerable to sustained low prices, but the sector has certainly not suffered as much as the Saudis would like. And the current price is hurting them badly.The Saudis "are bleeding red ink", says Liam Halligan in The Sunday Telegraph. The break-even price for the Saudis on oil is $90 per barrel; at these prices, they're running up a deficit of $500m a day.

The country has been withdrawing billions from its foreign-exchange reserves every month to keep itself afloat. Its cash pile has slipped from $774bn last December to $664bn in August.Overall public debt is very low, but set to mount quickly: the budget deficit this year is set to reach 20% of GDP.

The impact on markets

But the Saudis aren't the only ones pulling in their horns. Norway's sovereign wealth fund, worth $870bn, is the biggest in the world and owns the equivalent of more than 1% of every single equity in the world; it accounts for 2.4% of European stocks.The fund has seen a "precipitous drop in cash injections" from the government due to oil's slide, says Saleha Mohsin on Bloomberg.com. Other oil producers' sovereign wealth funds may also consider retrenching if prices stay low. This suggests that, for the first time in many years, equity markets can't count on much of a boost from money from sovereign wealth fund. Another tailwind for stocks is fading.

Nobel Prize-winner Robert Shiller of Yale University has a good track record on bubbles. His book Irrational Exuberance, which followed several warnings about overpriced stocks, appeared just as the dotcom bubble peaked. In 2005, he began to fret about US housing markets. Now, he reckonsUS stocks are due a fall. The S&P 500 has a cyclically adjusted price/earnings ratio (also known as the Shiller p/e) of 27, a level superseded only in 1929, 2000 and 2007, whereupon markets collapsed, he notes in Wirtschaftswoche. Note too that the last recession was eight years ago.

Usually there is a downturnat least every ten years, another reason to expect the party to end before long.In the 1990s, markets climbed from very expensive to absurdly expensive, so a crash may not be imminent. But Shiller says that this summer he sold some of his stocks, notably those that had risen for the previous six years. He reckons the Dow Jones could fall by 30%, and jitters will spread to other markets.

Recommended

What escalating tension between Iran and the US means for oil prices
Global Economy

What escalating tension between Iran and the US means for oil prices

The tension between the US and Iran is unlikely to mean all-out war in the Middle East. But markets may be getting a little too complacent about its e…
6 Jan 2020
Rising output will keep a lid on the oil price
Oil

Rising output will keep a lid on the oil price

Oil exporters’ cartel Opec gave further encouragement to the bulls this month after agreeing to new production curbs.
20 Dec 2019
Brace yourself for pricier oil
Oil

Brace yourself for pricier oil

Global growth, and hence demand for oil, could surprise on the upside next year, leading to a bounce in the oil price.
29 Nov 2019
The British equity market is shrinking
Stockmarkets

The British equity market is shrinking

British startups are abandoning public stockmarkets and turning to deep-pocketed Silicon Valley venture capitalists for their investment needs.
8 Nov 2019

Most Popular

The Bank of England should create a "Bitpound" digital currency and take the world by storm
Bitcoin

The Bank of England should create a "Bitpound" digital currency and take the world by storm

The Bank of England could win the race to create a respectable digital currency if it moves quickly, says Matthew Lynn.
18 Oct 2020
Don’t miss this bus: take a bet on National Express
Trading

Don’t miss this bus: take a bet on National Express

Bus operator National Express is cheap, robust and ideally placed to ride the recovery. Matthew Partridge explains how traders can play it.
19 Oct 2020
Three stocks that can cope with Covid-19
Share tips

Three stocks that can cope with Covid-19

Professional investor Zehrid Osmani of the Martin Currie Global Portfolio Trust, picks three stocks that he thinks should be able to weather the coron…
12 Oct 2020