QATAR TODAY > DECEMBER 2014 > 35
Over the last few weeks, risk asset classes have been sold off around the world and flights to safety have driven bond yields down. This has been attributed to a number of underlying anxieties but they all translate into worries about world economic growth. Coincidentally, the price of oil has fallen dramatically over the last month.
To put this in context, equity markets have had exceptional appreciation since 2009 with only modest corrections along the way. Despite an evident US recovery, several issues are giving risk allocators pause. Firstly, the Ebola contagion has now reached the US. Everyone is watching to see whether its healthcare system will contain the virus or if it has already been transmitted, but not yet diagnosed, in non-healthcare workers. If we see an expanded set of cases, this will rattle the markets again and selling will be driven by further anxiety about the US consumer withdrawal.
Secondly, the war in Iraq is one that frightens consumers, but our sense is that this is more containable than the first issue. Nonetheless it is contributing to consumer hesitation where world economies are still primarily driven by the consumer.
Impact on the region
First, there is the oil price decline, which is the most material driver of “well-being” for these economies. Many of these countries have wisely used oil profits to finance development and social programs in an effort to diversify away from oil dependence. The issue now is whether the drop in the oil price is at a point where it will have an effect on government spending. Just like Ebola can frighten the consumer, the price drop can lead to a reduction in a government's propensity to spend. Some countries have a high profit margin on oil production (like the UAE). Other countries like Iraq have much higher costs and are probably selling at a loss. Without substantial government reserves to subsidise this “selling at a loss,” there is a fragile unsustainable economic model. Governments effectively go into deficit spending to close the gap.
Either way, less profitable oil sales are likely to reduce government spending. Countries, like the UAE, have big plans and we expect that these will proceed. Others might consider trimming back their plans. For equity markets that have been dependent on government spending, there is a trimmed growth outlook and hence some potential equity market risk.
The second point for the region goes to containing the Ebola virus. There is still significant uncertainty according to health professionals but a uniform goal to eradicate it. The problem is that there are great lapses in the efficacy and speed to accomplish that goal. The virus spreads at its own geometric speed but unfortunately most governments move at “bureaucracy speed.”
The industries that are first affected are the travel and the hospitality industries; Ebola anxiety and the Middle East's unrest will certainly impact travel to the region.
The magnitude of this hit to confidence will be driven by the efficacy and speed with which the virus and regional conflicts are contained or not.
Hopeful for the future
Our longer-term outlook for risk assets is still bullish and we do not consider the recent pull back to indicate that we have entered into a “bear market.”
The issues facing consumer confidence and or MENA government spending confidence are at this point potential Black Swan events that could get worse before they get better. In all extreme points there are extraordinary buying opportunities.
Companies that have survived world wars are likely to continue to succeed and accordingly, one should be prepared to make long term investments in periods of potential extreme market dislocation
BY DAVID PINKERTON Chief Investment Officer Falcon Private Bank (Zurich)