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Shane Oliver
Financial markets
+ About Shane Oliver

Shane Oliver is head of investment strategy at chief economist at AMP Capital.

What to watch over the next week?

Monday, February 23, 2015

By Shane Oliver

In the US, the main focus is likely to be on Fed Chair Janet Yellen’s Congressional testimony (Tuesday and Wednesday), which is expected to confirm that the Fed remains on track to raise interest rates this year, but can be patient in doing so.

Meanwhile, data for new and existing home sales (Monday and Wednesday) are likely to show slight falls after strong December gains but with pending home sales (Friday) likely to be up, home prices (Tuesday) are expected to have risen further in December and durable goods orders (Thursday) are likely to show a decent rise after a few soft months.

Of particular significance, December quarter GDP growth (Friday) is likely to have been revised down further to a 2% pace and inflation is expected to fall to -0.1% year on year at a headline level with core inflation falling to just 1.5% year on year. Both of which are expected to add to the case for the first Fed rate hike to come later in the year rather than in June.

In the Eurozone, the focus will be on whether the interim loan deal with Greece is finalised.

In Japan, January data for household spending, industrial production and the labour market will be watched on Friday for signs that the recovery that commenced last quarter is continuing. January inflation data will also be released.

The flash HSBC China manufacturing PMI (Wednesday) will likely remain softish.

In Australia, December quarter data is expected to show that wages growth (Wednesday) remains at record lows with annual growth of just 2.5%, December quarter construction data (also Wednesday) is forecast to be weak with strength in housing offset by weakness in mining related engineering construction.

Business investment data (Thursday) will be watched for signs of improvement in non-mining investment plans. Private credit data will be released Friday with the main interest being whether housing investor credit is breaching APRA's 10% growth limit.

The Australian December half profit reporting season will wrap up with over 80 major companies reporting including BHP, QBE, Worley Parsons, Qantas and Woolworths.

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Earnings numbers and the week ahead

Monday, February 16, 2015

By Shane Oliver 

Earning results 

Its early days in the Australian December half profit reporting season with just less than 20% of companies reporting to date and there is also a tendency for the good results to come out early, but so far so good. Sixty percent of results to date have beaten expectations, against a norm of 45%, while 76% have seen profits rise from a year ago, 54% have seen their share price outperform the day results were released and 73% have increased their dividends.

Key themes have been weakness amongst resources shares (on falling commodity prices) and mining services companies (on falling mining investment), continued strength for the banks, ongoing cost control and solid growth in dividends. 

 

Source: AMP Capital Investors

What to watch over the next week?

Overseas

The week ahead is PMI (Purchasing Managers Index) week with preliminary business conditions indexes or PMIs released for the US, Europe and Japan on Friday. The US PMI is likely to remain solid around 53.9 and a further improvement is expected in Europe and Japan. 

In the US, the minutes from the last Fed meeting (Wednesday) are likely to confirm that it remains comfortable in the way the economy is progressing but for now it can be patient in moving to raise interest rates. Meanwhile, the home builders conditions index (Tuesday) is likely to show a small gain, permits to build to new homes (Wednesday) are likely to rise but housing starts (also Wednesday) are likely to have fallen slightly after a very strong gain in December. Expect the New York and Philadelphia regional manufacturing conditions indices (Tuesday and Thursday respectively) and industrial production (Wednesday) to remain solid and January producer prices (Wednesday) to show a further fall. The December quarter earnings reporting season will start to wrap up.

Eurozone finance ministers will meet Monday to continue discussions regarding Greece.

Japanese December quarter GDP data (Monday) is likely to show a return to modest growth after two quarters of recession inspired by the April sales tax hike. 

Australia

In Australia, the Minutes from the last RBA Board meeting (Tuesday) are likely to confirm that the door is open to another interest rate cut, but are unlikely to say anything new given the Statement on Monetary Policy and Governor Steven’s Parliamentary testimony that post-date the last meeting. 

The December half profit reporting season will really ramp up with 80 major companies reporting including Amcor, Fortescue, IAG and AMP. Consensus earnings growth expectations for this financial year are near zero, driven by an expected 25% drop in resource profits on the slump in commodity prices. However, the rest of the market is stronger with industrials expected to see growth around 10% and banks to see about 8% growth. Expect ongoing cost cutting, help from the lower $A and strong dividend growth to be key themes.

Outlook for markets

Notwithstanding the risk of a correction – potentially as the Fed eventually moves to raise interest rates - the broad trend in shares is likely to remain up as valuations, particularly against bonds, are good; economic growth is continuing; and monetary policy is set to remain easy with further easing in Europe, Japan, China and Australia and only a gradual tightening in the US. As such, share markets are likely to see another year of reasonable returns.

Commodity prices have been seeing a bounce from very oversold conditions, with oil in particular looking like it may have built a short term base around $US45/barrel. However, excess supply for many commodities is expected to see them remain in a long-term downtrend. 

Low bond yields point to soft medium term returns from sovereign bonds, but it’s hard to get too bearish in a world of too much saving, spare capacity and deflation risk.

Short term gyrations aside, the downtrend in the Australian dollar is likely to continue as the US dollar trends up and reflecting the long term downtrend in commodity prices and Australia’s relatively high cost base. We now expect a fall to around $US0.70, with the risk of an overshoot. However, the Australian dollar is likely to be little changed against the Yen and Euro.

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What to watch over the next week?

Monday, February 09, 2015

By Shane Oliver

Australian shares

Australian shares have been a star performer, having surpassed my (too optimistic) target for last year and my target for this year to now be up 7.6% year to date, which is up there with European shares.

Clearly the combination of lower interest rates boosting yield plays, the lower Australian dollar boosting earnings and a stabilisation in oil and commodity prices helping resources stocks are having a big impact.

While Australian shares are now looking a bit overbought in the short term (with the forward PE pushing above 15 times compared to a long term average around 14 times) and could see a correction or consolidation, the broad trend is likely to remain up.

 

What to watch over the next week

In the US, January retail sales (Thursday) ex fuel should bounce back after softness in December helped by low gasoline prices and consumer sentiment (Friday) should hold around an 11-year high. Data on small business confidence will also be released. US December quarter earnings results will continue to flow as the reporting season starts to wrap up.

Eurozone GDP data for the December (Friday) is expected to show growth of 0.3% quarter on quarter representing a slight improvement from the prior two quarters.

China’s January inflation rate (Tuesday) is expected to slow to just 1% year on year reflecting weaker food prices and the flow through of soft commodity prices to non-food inflation. This, combined with a steepening rate of decline in producer prices, is likely to add to pressure for further monetary easing. Money supply and credit data will also be released.

In Australia, a speech by RBA Governor Stevens (Monday) and his Parliamentary testimony (Friday) may add a little colour around the RBA’s latest interest rate cut, but is unlikely to change our view of another rate cut to come. ANZ job ads data (Monday) will likely continue to show modest growth, January NAB survey business confidence (Tuesday) will likely remain subdued, December quarter house prices are likely to show growth of around 2% quarter on quarter, consumer confidence (Wednesday) may get a boost from the latest rate cut and fall in petrol prices, housing finance (Wednesday) should show a bounce but employment (Friday) will likely have fallen by 10,000 after several unbelievably strong months resulting in a back-up in unemployment to 6.2%.

The December half profit reporting season will also start to get underway in earnest with 30 major companies due to report including Cochlear, Stockland, Telstra and Rio. Consensus earnings growth expectations for this financial year have already been wound back to near zero, driven by an expected 28% drop in resource profits on the back of the slump in commodity prices. However, the rest of the market is a bit stronger with industrials expected to see growth (for the fourth year on a row) of around 10% and banks to see about 8% growth. Given the difficult economic conditions the risks are to the downside, but ongoing cost cutting and help from the lower $A should be two key positive themes.

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What to watch over the next week

Monday, February 02, 2015

By Shane Oliver

In the US, expect to see a slight fall in the ISM manufacturing conditions index (Monday) but leaving it at a still strong reading of 55, continued strength in the non-manufacturing ISM (Wednesday) and another strong jobs report (Friday). January payrolls are expected to rise by a strong 235,000 with unemployment remaining at 5.6%. However, the focus in the jobs report is likely to be on wage earnings, which were surprisingly weak in December but are likely to have bounced back in January. The annual growth rate in wage earnings is still likely to be just below 2% though. Productivity and trade data will also be released. US December quarter earnings results will continue to flow.

In the Eurozone, final January business conditions PMIs (Monday and Wednesday are likely to confirm the slight improvements already reported in preliminary estimates.

In Australia, the RBA should cut interest rates by 0.25% on Tuesday.  Growth is too low, confidence is subdued, prices for key commodities like iron ore and energy have collapsed resulting in a much bigger hit to national income than expected a year ago, the Aussie dollar remains too high on a trade weighted basis and is set to bounce if the RBA fails to cut soon and benign inflation provides plenty of flexibility for the RBA to move. It’s not that I am bearish on the Australian economy. But rather it makes sense for the RBA to take out some insurance to make sure growth improves.

However, it’s a close call as to whether the Reserve will actually cut on Tuesday or wait till March as it may prefer to prepare the way for a cut by dropping the reference in its post meeting Statement to a “period of stability in interest rates” and by lowering its inflation forecasts in its Statement of Monetary Policy to be released Friday.

Ultimately it doesn’t matter a lot whether it’s in February or March, but the key is that interest rates need to come down and I expect they will either on Tuesday or if not then in March. But it would be easier to get the first cut out of the way now and hence avoid a short term bounce back up in the $A. Beyond the first cut there is a 50/50 chance of another cut taking the cash rate to 2% around May

Meanwhile, expect the TD Securities/MI Inflation Gauge (Monday) to show a further fall in inflation in January on further fuel price declines, a 3% pull back in building approvals (Tuesday) after November’s surge and a modest rise in December retail sales (Thursday) but good quarterly growth in real terms. Data for home prices (Monday), business conditions PMIs and the trade balance (Tuesday) will also be released. 

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What to watch over the next week?

Tuesday, January 27, 2015

By Shane Oliver

In the US, the Fed (Wednesday) is expected to reaffirm that it will remain patient in terms of when it will first start to raise interest rates and that it will be data dependent. While recent US economic and labour market data has been favourable it will be interesting to see how the Fed interprets the recent fall in core inflation. Our base case remains that the first hike will be in June, but with the risk of a delay. 

Meanwhile, on the data front in the US, expect gains in December durable goods orders, new home sales, house prices and consumer confidence (all due Tuesday) and pending home sales (Thursday). December quarter GDP (Friday) is expected to rise at a solid 3% annualised pace and the December quarter Employment Cost Index (also Friday) will likely also show continued modest growth. 

In Europe, the main focus will be on the outcome of the Greek election. It will be weeks or months before the outcome in terms of a Grexit from the Euro will be known. Syriza is no longer seeking to leave the Euro as it knows 70% of Greeks want to stay. But to stay it will have to reach agreement with the Trioka of the IMF, EU and ECB on its budget and reform program and to do this it will have to compromise. The pressure to do this will be immense because to not compromise will see Trioka funding withdrawn resulting in even worse austerity and ECB support for Greek banks removed. So I expect a deal to be struck. And finally, if there is no agreement and Greece does leave the Euro, the threat of contagion to peripheral countries is far less than it was in 2012 as Portugal, Ireland and Spain are now in much better shape and the defence mechanisms in Europe are far stronger with a strong bailout fund, a banking union and an aggressive ECB. 

Meanwhile, in Europe economic confidence indicators will be watched for further signs of stabilisation (Thursday) and the January CPI (Friday) is likely to show further modest deflation. 

Japanese economic activity data is expected to show further signs of improvement but inflation is likely to have slowed reflecting lower fuel prices (all due Friday). 

In Australia, expect the December quarter inflation rate (Wednesday) to have fallen below target leaving plenty of scope for another RBA rate cut. A 7% slump in petrol prices is likely to have resulted in inflation of just 0.1% quarter on quarter or 1.6% year on year. Underlying inflation is also expected to be relatively weak at just 0.5% quarter on quarter or 2.1% year on year. Both headline and underlying inflation are expected to come in below RBA expectations. 

Meanwhile the NAB business survey (Tuesday), trade prices (Thursday), producer prices and credit (Friday) will be released. 

Outlook for markets 

Uncertainties associated with the plunge in oil prices and the impact on energy producers, the Greek election and the Fed’s move towards a rate hike could result in a volatile first half in share markets with the risk of a 10-15% correction at some point along the way. 

However, the broad trend in shares is likely to remain up as: valuations particularly against bonds are good; economic growth is continuing; and monetary policy is set to remain easy with further easing in Europe, Japan, China and Australia and only a gradual tightening in the US. As such share markets are likely to see another year of reasonable returns

The Australian share market is likely to do better than in 2014 as growth continues to rebalance away from resources helped by low interest rates and the fall in the $A. However, it will probably continue to lag global shares as commodity prices remain in a long-term downtrend. Expect the ASX 200 to rise to around 5700 by end 2015. 

Commodity prices may see a bounce from very oversold conditions, but excess supply for many commodities is expected to see them remain in a long term downtrend. 

Low bond yields point to soft medium term returns from sovereign bonds, but it’s hard to get too bearish in a world of too much saving, spare capacity and low inflation. 

The downtrend in the $A is likely to continue as the $US trends up and reflecting the long-term downtrend in commodity prices and Australia’s relatively high cost base. Expect a fall to around $US0.75. However, the $A is likely to be little changed against the yen and euro. 

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What to watch

Monday, January 19, 2015

By Shane Oliver

The main focus in the week ahead will be the ECB meeting (Thursday), which is expected to announce an expansion in its quantitative easing asset purchase program to include corporate and sovereign bonds. This should help the ECB reach its target of expanding its balance sheet by around €1trillion.

While the initial QE program may be for a fixed amount, President Draghi is likely to indicate that this will be extended if needed. Meanwhile, Eurozone PMIs for January (Friday) will be watched for a further improvement after the slight gain seen in December. And on 25 January the focus will shift back to Greece with its election, albeit it may take a while to determine the new government.

In the US, expect to see gains in the NAHB home builders’ conditions index (Tuesday), housing starts (Wednesday), house prices (Thursday) and existing home sales (Friday) and the Markit manufacturing conditions PMI (Friday) to remain reasonably solid.

The flow of US December quarter earnings reports will pick up. Market expectations remain for profits to be up 2% year on year but this still looks too cautious.

The Bank of Japan meets Wednesday but no change in monetary policy is likely given the huge further easing announced several months ago. Japan’s manufacturing PMI will be released Friday.

Chinese December quarter GDP (Tuesday) is likely to show a further moderation in growth to 7.2%, resulting in 7.3% GDP growth for 2014 as a whole which is in line with the official target for growth of “about 7.5%”. Meanwhile, December data is expected to show growth slightly weaker for investment, flat for retail sales and up slightly for industrial production. The flash HSBC manufacturing conditions PMI for January will be released Friday.

In Australia, expect to see a bounce in consumer confidence (Wednesday) on the back of lower petrol prices and the reported fall in unemployment. Data for car sales and new home sales will also be released.

Outlook for markets

Uncertainties associated with the plunge in oil prices and the impact on energy producers, the 25 January Greek election and Europe and the Fed’s move towards a rate hike could result in a volatile first half in share markets with the risk of a 10-15% correction at some point along the way. This may already be getting underway.

However, the broad trend in shares is likely to remain up as:  valuations, particularly against the reality of low bond yields, are good; economic growth is continuing; and monetary policy is set to remain easy with further easing likely in Europe, Japan, China and Australia and only a gradual tightening cycle in the US. As a result share markets are likely to see another year of reasonable returns.

The Australian share market is likely to do better than in 2014 as growth continues to rebalance away from resources, helped by low interest rates and the fall in the Aussie dollar. However, it will probably continue to lag global shares as commodity prices remain in a long-term downtrend. Expect the ASX 200 to rise to around 5700 by the end of 2015.

Commodity prices may see a bounce from very oversold conditions, but excess supply for many commodities is expected to see them remain in a long-term downtrend.

Very low bond yields point to a soft medium-term return potential from sovereign bonds, but it’s hard to get too bearish on bonds in a world of too much saving, spare capacity and low inflation.

The downtrend in the Aussie dollar is likely to continue as the US dollar trends up and reflecting the long-term downtrend in commodity prices and Australia’s relatively high cost base. Expect a fall to around $US0.75. However, the Aussie dollar is likely to be little changed against the yen and euro.

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A list of lists for the economy and shares

Friday, January 16, 2015

Key themes for 2015

Okay but uneven global growth of around 3.5%, with the US being the world's locomotive, Europe and Japan lagging and China running around 7%. Global growth continues to help earnings, but it’s a long way from overheating.

A continuing secular downtrend in commodity prices in response to excess supply.

Low inflation, with the threat of deflation, on the back of global spare capacity and falling commodity prices.

Continuing sub-par real growth in Australia of around 2.5-3% in response to falling mining investment, the commodity price slump and budget cutbacks but with improved momentum by year end helped along by non-mining activity.

Easy monetary conditions with the US starting to gradually raise rates mid-year, but on going easing in Europe, Japan, China and Australia. The RBA to cut the cash rate further.

A further rise in the $US and corresponding weakness in the Euro, Yen and Australian dollar, with the Aussie falling to around $US0.75.

Further gains in shares, but with increased volatility and with global shares outperforming Australian and emerging market shares.

Key risks for 2015 – there’s always something!

Concerns about Fed rate hikes could trigger share market weakness, possibly with higher bond yields.

The slump in oil prices could trigger problems in energy producers, eg energy companies, Russia, Arab countries.

A return of the Eurozone crisis if ECB quantitative easing is not enough, deflationary pressures intensify or in response to political problems (eg, in Greece or Spain).

China’s property slump could trigger a hard landing there.

The loss of national income from lower commodity prices and the continuing unwind in mining investment could overwhelm the fledgling pick up in non-mining activity resulting in much weaker Australian economic growth.

Bubble trouble – the ongoing search for yield and returns could set off a bubble in various assets.

More geopolitical flare ups – eg, ISIS/terror threat.

Factor X – there is always something from left field.

Six indicators to watch

Global business conditions indicators (or PMIs) – these have been averaging around reasonable levels.

Wages growth in the US as a guide to how quickly the Fed may move on rates – so far it remains low.

The spread of Italian and Spanish bond yields to German bond yields – a good guide to whether the Eurozone crisis is continuing to fade. So far so good.

The ECB's balance sheet – it should start to rise with QE.

Chinese property prices – for signs of stabilisation.

Confidence indicators in Australia – these are a good guide to the state of non-mining activity and need to improve.

Five reasons to be optimistic on the US and $US

US Congress has been more constructive since the Tea Party was sidelined after the 2013 debt ceiling debate.

Low energy and labour costs have led to a renaissance of US manufacturing.

The post GFC deleveraging process has come to an end and rising wealth is supporting consumer spending.

The US budget deficit has fallen to around 3% of GDP.

The Fed looks set to raise interest rates at a time when other central banks are still easing policy (good for $US).

Three reasons why China will see growth around 7% 

Potential growth is trending down from 10% per annum plus last decade to around 6% pa by 2020 as the population slows and the easy gains of industrialisation are over, but...

Mini-stimulus measures over the last year or so highlight the government has no tolerance for a collapse in growth.

Chinese inflation is very low (with producer prices deflating) indicating plenty of scope for further monetary easing.

Four reasons for optimism about Europe

Eurozone shares are relatively cheap.

The ECB is stepping up quantitative easing.

Greece is a short term threat, but there is less threat of contagion now as Portugal, Ireland and Spain are now all stronger and defence mechanisms in Europe are stronger with a bailout fund, a banking union and an aggressive ECB.

The lower and still falling Euro will provide support

Four reasons not to despair on Australia

Interest rates are at generational lows and likely to fall.

The fall in the Aussie dollar is removing a major drag on growth.

There are signs of life in non-mining sectors of the economy: dwelling construction, retailing, tourism, higher education and manufacturing is also likely to see a boost.

Stronger export volumes (from resource projects) will provide a partial offset to lower commodity prices. 

Four implications of the commodity price downtrend 

Favour advanced countries (where commodity users dominate) over emerging countries.

Favour Asia (commodity users, economic reformers) over South America and Russia (commodity producers, reform resisters) when investing in emerging markets. 

Favour global shares over Australian shares, as the trend in commodity prices has gone from a tailwind last decade to a headwind this decade for Australia.

Favour the $US over the Aussie dollar, with the latter likely to fall to around $US0.75.

Five reasons pointing to the risk of a share market correction in the first half of the year

• Uncertainty around the impact of plunging oil prices on energy producers is likely to get worse before it gets better.

• Uncertainty about a Greek exit from the Euro and Eurozone deflation may also get worse before it gets better.

• The last time the Fed started to raise rates (in mid-2004) saw a weak first half 2004 in US shares.

• Given the parallels between now and second half of the 1990s (stronger US, weaker rest of world, falling commodity prices), it is noteworthy that as the bull market back then continued volatility picked up.

• Shares are no longer dirt cheap and there is a greater dependence on earnings.

...but five reasons why the trend in shares likely remains up

• Share valuations are still okay, particularly against the reality of low bond yields and interest rates.

• Global growth is continuing and this should help profits.

• As there are more consumers of oil than producers the lower oil price will ultimately be positive for growth and shares.

• Monetary conditions globally and in Australia are very easy and likely to get easier still as, while the Fed may start to tighten, other central banks are still easing.

• US shares which set the scene normally do well in the third year of the Presidential Cycle (which it is now) and in the fifth year of each decade. Since the 1880s all years ending in five (ie 1885, 1895, etc) have seen US shares rise.

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What to watch this week

Monday, January 12, 2015

By Shane Oliver

In the US, expect to see solid December retail sales growth (Wednesday), strong January manufacturing conditions in the New York and Philadelphia regional surveys but benign producer and consumer price inflation readings for December (due Thursday and Friday respectively). In fact, plunging energy prices are expected to push CPI inflation to just 0.8% year on year and core inflation is likely to remain low at 1.7% year on year. All of which should leave the Fed with plenty of scope to remain patient on interest rates.

The December quarter profit reporting season will kick off in the US with companies such as Alcoa, JP Morgan and Intel due to report. Consensus expectations are for just 2% growth in profits over the year to the December quarter, but this is likely to yet again prove too conservative with a final outcome likely to be closer to 6-7%.

In Europe the focus will be on European Court of Justice’s opinion (Wednesday) on the ECB’s Outright Monetary Transaction sovereign bond buying program. So far the OMT has not had to be implemented but an unexpected negative Court opinion on the ECB’s ability to buy sovereign bonds could impact its quantitative easing plans to be announced on January 22,  forcing it down a weaker path of having individual country central banks conduct any bond buying.

Chinese export and import data (Tuesday) are expected to show a slight improvement for December as is money supply growth but growth in total credit is likely to have continued to slow.

In Australia, expect to a small gain in housing finance (Monday), but only a 5000 gain in jobs leaving the unemployment rate stuck at 6.3% (Thursday). Data for ANZ job ads (Monday) and ABS job vacancies (Wednesday) will also be released.

Outlook for markets

Uncertainties associated with the plunge in oil prices and the impact on energy producers, the Greek election and Europe and the Fed’s move towards a rate hike could result in a volatile first half in share markets with the risk of a 10-15% correction at some point along the way.

However, the broad trend in shares is likely to remain up as: valuations, particularly against the reality of low bond yields, are good; economic growth is continuing; and monetary policy is set to remain easy with further easing likely in Europe, Japan, China and Australia and only a gradual tightening cycle in the US. As a result share markets are likely to see another year of reasonable returns.

The Australian share market is likely to do better than in 2014 as growth continues to rebalance away from resources, helped by low interest rates and the fall in the $A. However, it will probably continue to lag global shares as commodity prices remain in a long-term downtrend. Expect the ASX 200 to rise to around 5700 by end 2015.

Commodity prices may see a bounce from very oversold conditions, but excess supply for many commodities is expected to see them remain in a long-term downtrend.

Very low bond yields point to a soft return potential from sovereign bonds, but it’s hard to get too bearish on bonds in a world of too much saving, spare capacity and low inflation.

The downtrend in the Australian dollar is likely to continue as the US dollar trends up and reflecting the long-term downtrend in commodity prices and Australia’s relatively high cost base. Expect a fall to around $US0.75. However, the Aussie is likely to be little changed against the Yen and Euro.

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What does the oil price plunge mean for you?

Thursday, January 08, 2015

By Shane Oliver

The past year has seen the world oil price fall by more than 50%. Late last year as the fall accelerated this started to act as a drag on share markets and this has resumed at the start of this year as the oil price has continued to slide. But what’s driving the oil price plunge and isn’t a fall in oil prices meant to be good news?

Why has the oil price collapsed?
Put simply the oil price has collapsed because the global supply of oil has surged relative to demand. Last decade saw the price of oil go from $US10/barrel in 1998 to $US145 in 2008.

Black lines show long term bull & bear phases. Source: Bloomberg, AMP Capital

This sharp rise in the oil price, both in nominal and real terms, encouraged greater fuel efficiencies (use of ethanol, electric cars, etc) and more importantly encouraged the development of new sources of oil. A significant example of this has been the surge in US shale oil production this decade which has taken US oil production back to 1980s levels.


Source: Bloomberg, AMP Capital

This is similar to what occurred in response to sharp rises in oil prices in the 1970s, which then resulted in much weaker prices through the 1980s and most of the 1990s.

Other factors playing a role in the oil price collapse include:

  • Slowing growth in the emerging world. The emerging world was a key source of growth in oil demand last decade but emerging country growth has slowed over the last few years in response to various economic problems. In particular, Chinese economic growth has slowed to around 7% compared to 10% or so last decade.
  • A rise in the value of the US dollar in response to relatively stronger economic conditions in the US. This weighs on most commodity prices as they are priced in US dollars. However, the oil price has also collapsed in euros, Yen and the Australian so its not just a strong US dollar story.


However, the surge in the supply is probably the main factor. In fact it was arguably OPEC’s decision last November not to cut production, but rather to maintain it and try and force other producers to cut, that has accelerated the fall.

In a big picture sense oil is just part of the commodity complex with all major industrial commodities – metals, gold, iron ore – seeing sharp price falls over the last few years as the commodity super cycle has shifted from excess demand to one of excess supply.

How far could the oil price fall?
How far the oil price will fall is anyone’s guess just as how much it would rise last decade was. However, history tells us that it can fall much further than you think until supply is finally cut back. In the 1980s and 1990s the oil price fell more than 70% before the bottom was hit (see the next chart). More recently oil prices plunged 78% through the GFC but the fall was short lived and supply in recent years has expanded, not fallen, as a result of the US shale oil revolution.

Source: Bloomberg, AMP Capital

So a fall back to around $US40 a barrel or just below, ie a roughly 75% fall from the 2008 level, is reasonably likely. This level should start to force supply cutbacks amongst more marginal producers but, as we saw in the 1980s and 1990s, once prices bottom its likely to be followed by a period of base building rather than a quick surge back up.

What are the impacts of low oil prices?
The plunge in oil prices has both positive and negative implications. This has been reflected in sharp falls in energy share prices and a back up in high yield debt yields in the US, reflecting concerns about indebted US energy companies, and a collapse in the Russian sharemarket and Ruble on worries about the oil dependent Russian economy and a re-run of the 1998 Russian debt default. And it’s these more visible impacts that have dominated the broad share market reaction to the oil price plunge over the last few months.

However, lower oil prices are a huge positive for the global economy generally. Oil price hikes lift business costs and are like a tax on households and so a surge in oil prices played a big role in the recessions of the mid 1970s, early 1980s, early 1990s and in 2008-09. This all works in reverse for oil price slumps as business costs fall and the lower price of fuel provides a boost to household spending power. Rough estimates suggest a boost to growth in industrialised countries, and Australia, from the 50% fall in the price of oil of around 0.7% if the fall is sustained. Asia is likely to see a slightly bigger boost as most of Asia is a net importer of oil.

Lower energy prices will also bear down further on inflation, which in turn will mean more pressure on China, Japan and Europe to ease further and a possible further delay in the timing of the first Fed rate hike. In Australia the December quarter CPI to be released later this month is likely to show inflation running around 2%, providing plenty of scope for further RBA easing.

For Australian households, the plunge in the global oil price adjusted for moves in the Australian dollar indicates average petrol prices have further to fall towards $1/litre (see next chart), as the usual lags work through. In fact, some service stations have already dropped the petrol price to 99.9 cents a litre.

Source: Bloomberg, AMP Capital

Current levels for the average petrol price of around $1.13/litre represent a saving for the average family petrol budget of around $14 a week compared to mid last year. If sustained, this will amount to $728 a year, which is a significant saving. If the 99.9 cent/litre price becomes the norm then the saving will rise to $988 a year (see next chart). Some of this extra discretionary income will likely be spent.

Source: AMP Capital

So the fall in oil prices should provide a solid boost to growth over the year ahead.

Implication for share markets
Share markets have initially reacted negatively to the fall in oil prices because the negative impact on energy producers is what is most visible and this is being magnified by the steepness of the fall. To be sure this impact could linger for a while yet and some sort of blow up – like further problems in Russia or a default by a more marginal energy company – cannot be ruled out.

However, the risk of a major threat to the global economy or share markets from energy producers is low:

  • US energy production was a bigger share of the US economy in the 1980s and yet the mid 1980s collapse in oil prices helped boost the economy and share markets back then;
  • While the Russian economy is facing a crisis (made worse by its own actions in Ukraine), a 1998 style Russian public debt default looks unlikely. Russian public debt is low at around 9% of GDP, compared to more than 50% of GDP in 1998, public debt in foreign currency is trivial and foreign exchange reserves are much higher now. Private debt is more of an issue now but much of it is owed by just two companies (Gazprom and Rozneft) who have foreign exchange earnings and the Russian central bank has indicated it will help companies meet foreign exchange obligations.

More broadly, it’s likely that over time the positive impact on global growth, and hence profits, from lower oil prices will dominate and this will help drive share markets higher by year end. After oil prices plunges into 1986, 1998 and 2008 US shares gained an average 23% over the subsequent 12 months.

As a result, any significant dip in share markets in response to lower oil prices should be seen as a buying opportunity.

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Summer reads – the economists’ favourites

Wednesday, January 07, 2015


Shane Oliver, head of investment strategy and chief economist, AMP Capital


My favourite investment book is…Benjamin Graham's The Intelligent Investor because it’s the classic book providing a sound basis for successful investing.

My favourite book is…Terry Goodkind’s Wizard's First Rule. It's a great fantasy book in what I regard as the best fantasy series. And full of lots of philosophy.

I’m reading now…Robin Hobb’s Assassin's Quest. Another great fantasy writer. As you can see I love fantasy books. Great way to relax.


David Bassanese, economist and Switzer expert


 

My favourite investment book is…. Building Wealth in the Stock Market by Colin Nicholson.
My favourite book isAdventures of Huckleberry Finn, Mark Twain.
I’m reading nowOutliers by Malcolm Gladwell.

Craig James, chief economist CommSec



I’m watching… Nikita, Covert Affairs, and Person of Interest.
(Craig told us that he wasn’t a big reader and suggested we ask his colleague Juliana Roadley.)

Juliana Roadley, senior manager media and Content, CommSec

My favourite investment book isThink and Grow Rich by Napoleon Hill.
My favourite book isWomen Who Run With the Wolves by Clarissa Pinkola Estes.
I’m reading nowMedici Money: Banking, Metaphysics, and Art in Fifteenth-Century Florence by Tim Parks.

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