I therefore maintain my long-term bullish view on oil prices. Most of the weakness is now behind us, but I will admit that prices can go anywhere in the short term. However, when we enter 2017 (and perhaps even earlier), inventory levels will at least have stabilised, and oil prices will begin to creep upwards again. Shale will prevent us from seeing oil prices at $100+ anytime soon, though.
What it all means
Regular readers of the Absolute Return Letter will know that, back in January, I listed the EM crisis as one of my leading candidates for ‘story of the year’ in 2016, and I pointed out how it could quite possibly negatively affect asset prices world-wide. That the story has unfolded this early in the year has admittedly taken me by surprise, but the fact that it has unfolded at all has certainly not.
After the significant damage that the GFC did to the financial system across DM countries, both banks and their regulators are constantly on their toes to avoid another calamity, and they are now tightening credit conditions in emerging markets. Total credit to EM corporates actually fell in the third quarter of last year – for the first time since 2009.
This has created a rather bizarre situation. Where common sense would suggest the supply side to cut back when prices fall and follow the logic in chart 7, the exact opposite has happened. Suppliers of various commodities (not only oil) have actually increased production as prices have fallen – presumably to service their rising debts. There is a first time for everything, I suppose.
Having said all of that, this is not the first time that a crisis has hit the emerging markets. In 1997-98 the so-called Asian crisis did substantial damage to equity prices as well as commodity prices, and the ultimate saviour back then turned out to be the combination of low commodity prices – in particular low oil prices – and very competitive foreign exchange rates.
I see no reason why the present combination of low oil prices and attractive foreign exchange rates shouldn’t invigorate economic growth across emerging markets, just as it did it back then. After all, the fall in oil prices this time has been even bigger than it was in 1997-98 (chart 8).
EM equities could quite plausibly end up being the bargain of the year, although I am concerned about corporate leverage in many EM countries. One would therefore have to step carefully.
Finally a general observation: This is not a repeat of 2008, as many have suggested. An EM crisis is not likely to do nearly as much damage to the financial system in our part of the world, as the GFC did. Why? Because the banking system in DM countries have only limited exposure to corporates in EM countries. Recession? Possibly. 2008 all over again? No.
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