WAKEUP, NA­TIONS

QATAR TO­DAY > DE­CEM­BER 2014 > 35

Qatar Today - - OIL & GAS > VIEWPOINT -

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)

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