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Cheap Oil Is Rich Opportunity for Asia

Published: 08:20 07 Jan 2015 GMT

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Cheap Oil Is Rich Opportunity for Asia 

Here is a section of this column William Pesek for Bloomberg: Across Asia, the lowest crude prices since 2009 are an almost unmitigated boon. Already, they've given Indonesia and Malaysia room to curb budget-busting fuel subsidies (although Malaysia, an energy exporter, will suffer from a drop in oil revenues). In Japan, the Philippines, Singapore, South Korea, Taiwan and Thailand, sliding energy costs stand to boost disposable incomes, household demand and corporate profits. Economist Glenn Maguire at Australia & New Zealand Banking Group thinks this "confidence multiplier" will lead to higher-than-expected growth. The drop in oil prices so far could add as much as 1 percentage point to global output. "We think this will be the defining, constructive dynamic that underpins Asian growth in 2015 and most probably 2016," Maguire says.

As India's Modi prepares to unveil his first full budget in February, he could hardly ask for a fairer tailwind. In the short run, says Peter Redward, principal at Redward Associates, oil trends will lead to a "massive improvement" in India's current account deficit, repair the government's balance sheet and restrain inflation, which should allow the central bank to cut rates.

Whether the pickup in growth can be sustained will depend on how bold Modi chooses to be next year. The Indian prime minister wisely slashed diesel subsidies when oil prices dropped, easing the hit consumers felt at the pump. But that was the easy part; it’ll be tougher to cut subsidies on liquefied petroleum gas and kerosene, which millions of Indians use for cooking. Together with diesel, subsidies for those two fuels cost the government $11 billion in the last fiscal year. Likewise, Modi will have to spend considerable political capital to abandon discounts on fertilizer. Without such cuts, it'll be difficult to free up space for more productive fiscal spending on infrastructure, education and health care. 

Nor can Modi afford to delay supply-side reforms. In addition to lower fuel bills, 2015 will feature a light election calendar: Only two of India’s 29 states will hold contests. This could well be the prime minister's best chance to push through politically difficult measures, such as allowing foreigners to hold majority stakes in key domestic sectors.

David Fuller's view 

Modi is ambitious, experienced and far more economically savvy than the head of government in most other countries, developed or undeveloped.  He also has an overall majority and a responsible central banker, so I do not think he needs our advice on how to run India’s economy. 

All politicians need an element of luck, and considerably lower oil prices are a huge benefit for all countries which import most of their energy.  Luck has favoured them, although today’s prices for crude oil are in reality, a triumph for US technology.  Modi would also benefit considerably from a good monsoon, which he did not get in 2014. However, this is in the hands of the weather gods.   

This item continues in the Subscribers’ Area.

 

Email of the day 1 

On the third industrial revolution:

“I fully agree with your sense that the Third Industrial Revolution has a long way to run. I give presentations on this topic around the world. Analysis of the 1st and 2nd Industrial Revolutions shows they spanned 3-5 decades and involved not only a new communication system but new financial systems and new energy sources too. The 1st Industrial Revolution from 1780-1830 involved synergy between the new energy source (coal), the new communication system (coal-powered printing presses leading to mass newspapers and mass education for the first time ever, and the new financial system (the London stock market. The 2nd Industrial Revolution from 1880-1920 was driven by oil then electricity as the new power sources, the telegraph then telephone as the new communication system, and the Limited liability company as the financial breakthrough. Our present-day 3rd Industrial Revolution began with the Internet in the mid-1990s, and that part is progressing nicely. But the new energy source (solar) is only just getting going, and we await a new financial system! When all three are in place and well-developed decades from now the world will be a very different place. Though I doubt the economics profession will have progressed quite so much!”

David Fuller's view 

Thanks for your informative email on a favourite subject, and your droll concluding sentence was also appreciated. 

Perhaps I lack imagination (or have too much of it) or hope to see too much more in my lifetime, but I think this ‘Industrial Revolution’, which I refer to as a visibly accelerating rate of technological innovation, has no natural end.  It includes the internet of everything, achieved with miniaturisation, plus new manmade resources such as graphene which will vastly improve the efficiency of many products, from solar energy panels to infrastructure construction.  I believe that within the lifetime of middle-aged people we will also see new nuclear in various different forms and possibly also the holy grail of commercial nuclear fusion.  I also think we are only approaching the foothills of what will be an accelerating rate of development in artificial intelligence. Sentimentally, I hope that Stephen Hawking’s recent prediction on AI does not come true, although his conclusion was certainly logical. 

Lastly, I hope those of us in the London area and attending Markets Now on 12th January (see below) will question speakers’ views, not least Charles Elliott on his choices for performance among technology shares.      

 

The Weekly View: Outlook 2015 Highlights: The Policy Pendulum Swings 

My thanks to Rod Smyth, Bill Ryder and Ken Liu of RiverFront for their excellent timing letter.  Here is the opening:

The Economy: Euro QE + Cheap Oil = Stronger global growth.  Our theme for 2015 – The Policy Pendulum Swings – is designed to capture our view that 2015 will see not only a policy swing from the US to Europe, but also highlight that the global economic clock is always ticking.  It is now six years since markets bottomed and the global economy started to dig its way out of the ‘Great Recession’.  US policymakers were the first among major economies to recognize the deflationary risks posed by the collapse of property prices and the global financial crisis.  Their proactive stance has led to faster economic growth, higher asset prices and a full recovery in corporate profits and profit margins.  When combined with a stronger dollar and cheap oil, we think non-US developed world growth will accelerate in 2015 and give a greater boost to share prices overseas than in the US, which has enjoyed decent growth for several years. 

David Fuller's view 

I hope they have not overestimated the EU’s quantitative easing (QE).  Super Mario Draghi of the ECB is a force field on his own and given a free hand would be aggressive in his efforts to head off further deflation.  However, the German alliance was raised on memories of hyperinflation between January 1919 and 30th November 1923.  

This item continues in the Subscribers’ Area, where The Weekly View is also posted.

 

The Markets Now 

Monday January 12th, 5:30pm to 8:30pm, at East India Club, 16 St. James Square,London, SW1Y 4LH

David Fuller's view 

We live in fascinating times which I look forward to discussing with you. Here is the brochure for this opening session of 2015.  There are certainly plenty of opportunities in the markets, in addition to some inevitable risks which we all hope to avoid.  We have an interesting new guest speaker - Charles Elliott - who will talk about the exciting field of technology in which we all have an interest.  Our November session at the East India Club was a sell-out, attracting plenty of knowledgeable delegates who contributed to a lively session.  I expect the same in January and hope you will come along with any guests who would benefit, and do not hesitate to participate in the discussion of prospects and risks for 2015.  If you have the time, please also join us for a drink and further chats at the Club’s cash bar after 8:30pm.

Good news - Bruce Albrecht will also be able to give a short presentation at this seminar.

Please note: There are a few seats left.  Fuller Treacy Money subscribers can still join at the £50 rate, and bring a guest for the same amount.  The early-booking rate has now expired for non-subscribers.

 

Commodities Outlook 2015 

Thanks to a subscriber for this report dated December 15th from Deutsche Bank which may be of interest. Here is a section: 

The fundamentals of copper do not mirror that of oil. In copper, there is no technological breakthrough which has opened up vast new resources, therefore copper should not suffer the same fall in pricing as that of oil. The fallout from oil has however impacted the overall sentiment towards commodities. However, copper remains a well-supplied market, and a lower oil price in combination with weaker producer currencies will lower the marginal cost support level, which we now estimate at USD5,800/t.

We continue to forecast a surplus market in copper for 2015E and 2016E, which in our view will see prices grind lower. However, we have cut the magnitude of the surpluses in both 2014 and 2015E by 200kt over the course of the year. The big increase in mined supply growth that we had previously forecast has been eroded by the latest round of downgrades to company guidance. Although we forecasts a more substantial surplus in 2016, we think risks are skewed to the downside, given the poor industry track record in delivering growth.

Eoin Treacy's view 

A link to the full report is posted in the Subscriber's Area.

Energy represents a significant cost for mining companies and has been a major contributor to the commodity price inflation witnessed over the last decade. One might expect lower energy prices to be a benefit for mining companies and they are. However the hard reality is this only helps marginal producers to survive longer and therefore prolong the supply surplus.

Oil prices are accelerating lower so energy costs for mining operations have halved since the summer. This has contributed to the recent weakness in the industrial metal prices. The LME Metals Index broke downwards to new three-year lows this week and a clear upward dynamic would be required to check potential for additional weakness. 

 

Top Bond Managers Plan for 2015 Energy Rebound 

This article by Matt Robinson for Bloomberg may be of interest to subscribers. Here is a section: 

Ken Leech, chief investment officer at Western Asset Management Co., has been adding energy assets slowly, including debt from California Resources Corp., an exploration and production company. The Western Asset Core Plus Bond fund gained 3.02 percent after the risk adjustment.

Leech said he sees value in CMBS, residential-mortgage backed securities and U.S. investment-grade corporate bonds. The extra yield investors demand to hold company debt rather government notes rose last year for the first time since 2011 on slower global growth, which reduced returns. That trend probably will reverse this year as the economy accelerates.

Eoin Treacy's view 

I highlighted a number of high yield ETFs in a piece before Christmas when they were testing areas of previous resistance. I was led to this investigation by curiosity as to whether they had been affected by the fall in oil prices. What I discovered is that funds like HYG do not hold appreciable quantities of energy sector debt and that the sell-off in high yield was more macro focused. 

In an effort to ascertain what effect the fall in oil prices has had on the debt markets I performed a search on Bloomberg for junk bonds, with ratings below BBB- and in the energy sector. Coal companies, a number of which are at risk of bankruptcy, have the highest yields. 

 

Rate-cut, reform & re-rating in the Year of the Ram 

Thanks to a subscriber for this report from Deutsche Bank focusing on China. Here is a section: 

Macro: Broad-based easing to bottom line ; watch CPI & RMB

We forecast lower-than-consensus GDP in 1H15, while 2H15 may see a minor pick-up thanks to rates and RRR cuts in 1-3Q15. We think the policy regime bottom line, but refrain from suggest closely watching the developments in CPI (esp. pork prices) and RMB depreciation to gauge how far the policy easing could go. 

Earnings: Non-financial earnings to recover at the expense of financials

We see a decent recovery in non-financial earnings growth to 8% in 2015 (vs. 0% in 2014), thanks to profit margin expansion amid softening commodity prices and falling financial costs. However, financials earnings growth may slow to 3% in 2015 (vs. 8.5%), sending overall H-share earnings growth to 5.5% (vs. 4.4%). This trend may extend in 2016 and H-share earnings could grow at a similar 5.4%. We believe cost cutting has its limit for Chinese corporate, top-line is still needed for a more sustainable earnings recovery. 

Liquidity: When G2 diverges the loosening PBoC vs. the tightening Fed

H-share liquidity conditions may weaken due to 1) further global capital outflows alongside the tightening Fed and strengthening US dollar, and 2) the mounting northbound while lukewarm southbound flows in the Shanghai Connect. A-shares may continue to benefit from the loosening PBoC and outperform H-shares, but in the near term, we would watch out for prudential measures given recent rapid leverage build-up, esp. via alternative channels. 

Valuations: 8-11x the fair range; market to enter

Modeling MSCI China with a three-stage DDM, we estimate 8-11x 12-month forward P/E as the fair valuation range. We expect the index to re-rate from the current 9.4x 12-month forward P/E to 10x by end-2015, based on 3.5% RFR and 6.5% risk premium. Also, considering around 5% rollover in 12-month the rising P/E and EPS boosting the index by 12% to 74 by end-2015.

Eoin Treacy's view 

A link to the full report is posted in the Subscriber's Area.

The Chinese mainland’s stock market remains in robust form despite the short-term overbought condition currently evident. This explosive breakout will roll over into a consolidation of gains at some point but a clear downward dynamic, held for more than a day or two, would be required to check momentum. 

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