SINGAPORE (Jan 10): Simmering tensions between the US and Iran have spilt over into a war of words and some missile strikes, one of which killed an important Iranian general. The US says no one was killed. So far, these exchanges have resulted in a knee-jerk spike in oil prices and some volatility in equity markets. But this did not last in the face of tepid oil demand and the US presidential cycle.
“In our base case of no major military escalation, the effects on economies and earnings on a global scale should be minor. Hence, we maintain our overweight positions on global and US equities. Outside a severe disruption scenario, we do not believe that oil prices can sustain at current levels,” says Kelvin Tay, Regional Chief Investment Officer Asia-Pacific at UBS Global Wealth Management.
Tay may have a point. Over the past five years, the S&P 500 Index has outperformed West Texas Intermediate by 30% (See chart 1).
However, not all market watchers are as sanguine. “West Texas Intermediate crude oil futures have appreciated by more than 5.4% over growing tensions in the Middle East. The US missile attack on top Iranian general Qassem Soleimani on Jan 3 has intensified fears of a growing conflict and disruptive effects towards global oil supply in the Middle East,” notes Benjamin Lu, commodities analyst at Phillip Futures. “Oil prices look poised to trend higher as markets remain cautious over political developments and militaristic concerns for the immediate term,” he adds.
US turns net crude oil exporter
Increasingly though, the ebb and flow of oil prices are not likely to impact the US as they did in the mid- to late 20th century and the first decade of the 21st century. Although the US is a large energy consumer, in September 2019, the US became a net exporter of all oil products, including both refined petroleum products and crude oil.
US Energy Information Agency (EIA) data show that the US exported 90,000 barrels per day more total crude oil and petroleum products in September last year than it imported. “This is the first month recorded in US data that the US exported more crude oil and petroleum products than it imported,” EIA notes. EIA expects total crude oil and petroleum net exports to average 570,000 b/d in 2020 compared with average net imports of 490,000 b/d in 2019.
“Asia takes an increasing share of global imports, and gross oil exports from the US overtake those from Saudi Arabia by the mid- 2020s,” notes International Energy Agency (IEA) in its World Energy Outlook (for 2020) issued in November last year.
IEA forecasts that the US will account for 85% of new global crude output and 35% of new natural gas through 2030. The US EIA expects US crude oil production to average 13.2 million barrels per day in 2020, an increase of 0.9 million b/d from the 2019 level. “Ultimately, it will be a burgeoning US export business that will mandate new output,” EIA says adding that the country’s oil use will remain flat or even decline slightly.
In IEA’s World Energy Outlook, the agency models three different scenarios for the world’s future oil demand. The first scenario is Current Policies which has a status- quo forecast that does not anticipate much change to ongoing growth trends. The second scenario is Sustainable Development which provides a strategic pathway to meet global climate, air quality, and energy access goals in full. The third scenario Stated Policies mirrors the plans and ambitions announced by policy makers around the world without trying to envision how these plans might change in the future.
Current Policies has annual oil demand continuing to rise at recent levels of 1.2 million b/d or so for many years to come. In contrast, Sustainable Development has oil demand peaking soon and then falling back to 67 million b/d by 2040, a level last seen in 1990. In the Stated Policies Scenario, global oil rises by around 1 million b/d on average every year until 2025.
US presidential cycle
In general, strategists are looking beyond Middle East tensions to stock market gains. “While volatility will likely remain elevated, a market drawdown is not imminent. In fact, over the last 19 US presidential election cycles, stocks have suffered losses just twice in the 12 months leading up to election day, delivering an average return of 8%,” Clear- Bridge Capital notes.
The theory behind the US presidential cycle is that stock market performance follows a pattern. In years one and two of a presidential term, the President exits campaign mode and works hard to fulfill campaign promises before the next election begins. For this reason, the first year is typically the weakest of the presidential term and the second year is not much stronger than the first. In years three and four of the Presidential term, the President re-enters campaign mode and works hard to strengthen the economy. For this reason, the third year is typically the strongest of the four and the fourth year is the second-strongest of the four.
Investors should stick to high-quality growth companies with strong moats around their businesses and more defensive areas of the market as these companies usually hold up well during turbulent periods, ClearBridge Capital indicates. “One of the benefits of these [high quality] stocks is dividends, particularly given the low yields on bonds in general. It’s worth noting that through the third quarter of 2019, 42% of S&P 500 stocks had a higher dividend yield than the 30-year US Treasury bond.”
Tay of UBS suggests investors use strategies to reduce volatility. “Investors worried about deploying capital can also take advantage of relatively low volatility in the option market at present to make use of strategies that reduce portfolio volatility or add explicit protection.” He also recommends safe have assets such as the Japanese Yen and gold. “Regarding the yellow metal, muted US economic growth and lower real interest rates reduce the opportunity cost of holding gold. And, since gold is priced in US dollars, a weaker dollar, which we expect in 2020, supports gold prices,” Tay says.
Asean promise
According to HSBC Private Banking, in the new decade, Southeast Asia is expected to become the fourth largest economic bloc, after the US, China and Europe. The locomotive behind Southeast Asia growth story is powered by urbanisation, demographics and digital revolution, according to HSBC.
“We forecast consumer spending in Asia ex-Japan to grow by 5.8% in 2020 and 5.9% in 2021, well above the average global rate of 2.5% in 2020 and 2.6% in 2021. Within Asia, we favour the domestic consumption story of China, India and the Asean countries, and the attractive opportunities in personal services, e-commerce, high-end consumer goods, entertainment, travel, education, healthcare and financial services,” says Fan Cheuk Wan, Chief Market Strategist for Asia, HSBC Private Banking.
Martin Currie, the specialist active equity manager organisation, believes emerging markets could be poised to replace the US as the main engine of global growth. “In the US, economic activity has been waning, principally caused by trade tensions with China. There are green shoots in the negotiations, but as tensions have escalated and tariffs have affected supply chains and product price inflation, the economy has slid closer to recession.”
On the flip side, Martin Currie expects earnings downgrades for Asian equities have run their course. “The ratio of earnings upgrades to downgrades in Asia has been exhibiting signs of stabilisation and may have already bottomed – any modest improvement in the underlying business environment will filter swiftly into this ratio and drive stock prices higher.”
To date, no one is expecting the US-Iran skirmishes to turn into a full blown war; markets do not like geopolitical event risks and such an outcome would be negative.
