As anticipated given the PE ratio's of companies in the DOW, troubles in China coupled with rising concerns about the strength of the global economy, pushed a lot of investors sitting on 2016 gains to head for the exits. The trouble began when Chinese stock holders, who primarily are retail shareholders sought to reduce their holdings and sent their bourses downward. This trigerred the government's automatic market stop, or safety valve. The safety valve had the opposite effect to restoring confidence. It increased the panic of sellers now trapped in a declining market and increased their desire to get out. Herd panic creates stampedes.
Meanwhile hedge funds and larger institutional funds who had locked in gains through the early part of 2016 had read the tea leaves of the US fed raising rates and saw that the stock markets ascent was past intrinsic value and baled out of equities. Thus has billions been wiped off stock values.
The trends for 2016 are not encouraging - we have declining Chinese exports and productivity, turbulence in Latin America and capital flight out of emerging markets. This with near stagflation in Europe and Japan, despite unprecedented QE. The USA has been the anchor to the global economy and appears to be progressing well. However the heady days of 4% annual economic growth and what is desired by the Fed to enable normalisation of interest rates is a distant memory. Anaemic growth of 2% or thereabouts appears stellar by comparison with Europe, Asia and Latin America. The liquidity pumped into the global economy to head off the crash has created mountains of debt. This debt is dragging on economies like an anchor. Competitive devaluation across China, Europe and Latin America at the same time merely serves to dampen inflation everywhere....the benefits of such devaluation inflict more pain, when your neighbours decide to do the same. Consider it as three neighbours in a terrace trying to sell their homes at the same time, each one dropping prices consistently on the other at a time when buyes are scarce.
We may be living through a new era where demographic ageing of all economies coupled with the manufacturing productivity of automation and digital mean that the "real" or old world economy ideal of consistent solid world GDP growth of 3% and 4% is behind us. The present oil price is a chimera. As soon as it rises past $60 and $80 dollars per barrel again, the competive offerings of shale, wind and solar, become more economic. However from its prices today, that may or not be some way off.
The political instability of cheap oil is hurting Saudi Arabia's economy most. As the Saudi's flood the global oil market to eliminate competition through insolvency, oil storage rises at a time when refinement capacity is stagnant. The supply side is in a glut, the demand side is weak and in the middle is a refining bottleneck which can neither purify the oil glut quickly for producer or customer. The large oil majors are cutting exploration, recovery, investment and employment. That said Saudi is experiencing unprecedented costs in its approach to maintain production volumes - some 33% of its annual reseves in a year by all accounts. Anyone taking bets on when they'll reverse gear?
Cheap oil is a boon to western markets. The oil price can only rise when demand exceeds supply. Certainly cheap oil stimulates demand. When the demand curve approaches the supply curve how will a higher oil price impact economies who have already adjusted to lower energy costs and still are not robust enough to absorb shocks?
All of this really only matters if you're a short term investor. Value based investors look at potential over cycles and several years. After all, every business and portfolio rises and falls depending on luck, its product position and its strategic responses to its markets.
Warren Buffet the sage of Omaha has effectively called the bottom of the oil market...its hard to see oil go below €28 a barrell. If it does how long can it stay there? When Shale capacity has been mothballed and OPEC or Saudi or both decide they have experienced enough pain, who will be the winners? After every crash there are some winners. If you can spot the winners now, then good for you. I think I'll follow Mr Buffet and buy Phillips refiners and perhaps some global oil giants down on their luck.
Rapid economic growth is exciting. As Ireland posts near 5% annual growth, let's not forget this is largely due to cheap energy, low interest rates and a competitive euro supporting exports. Interest rates may remain low but the Euro may rise against the dollar and sterling - this erodes our competitiveness. Some 40% of German output is directed at China. As the German economy slows so will Europe remain weak. Who knows where things will end? One thing for sure is our exports will slow as our customers find us more expensive and avail of lower cost offers from their own region. One future we must follow more closely is digital. The great democratic disruption of digital is to allow a man in his garage disrupt an industry and for a circuitboard and robotic arms eliminate a workforce.
Its time for a long term investment strategy - one which balances safety with growth. After one of the longest bull runs in history, equities are not going to continue to outperform reality. Long term trends are worth watching as history repeats itself and the cycle of growth, decay and growth again ploughs on.
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