Cebu, PHILIPPINES, Jan 13, 2015 – As a new year dawns upon us, we at Li & Hungerford provide you with the major trends that could define the year and the way you invest in 2015.
The price of oil defining the global economy
We are now well out of the commodity upswing that Chinese demand created following the global financial crisis, and along with new sources of energy and falling demand, producers are now having to come to terms with a glut of supply in many commodities.
It looks like coal will continue to fall from its previous high of US$180 a tonne and continue a steady decline into purgatory. Coking coal may level out depending on whether Chinese construction rebounds, although not likely before 2018, but despite aggressive cost cutting but larger producers, and the likely closure of many smaller ones, thermal coal will likely continue to fall below $75 per tonne this year, and continue to fall as lower demand and competing sources of energy, as well as the surprising environment momentum generated by the China-US agreement, will continue to squeeze.
Iron ore is also facing a similar trajectory, as over capacity continues to expand the global supply of the commodity and moderate demand has led to a 50% fall in price over 2014. Chinese output has not slowed despite its unprofitability. With such overcapacity, demand for housing is unlikely to rebound in 2015 so we expect the price of iron ore to remain depressed at US$65 a tonne.
However, by far, the weak price of oil will be a defining storyline within the global economy. Ratings agencies officially gave up on a resurgence in oil prices this year cutting their Brent crude prediction for 2015. Standard & Poor’s 2015 projection is now just US$55 per barrel, while Goldman Sachs slashed their three-month target to US$42 per barrel, down from US$80. As the revision was being broadcast it fell to a new five year low of US$49.30 and has continued to drop precipitously.
A by-product of the collapse of the oil price has been the falling forward estimates of the price of gas. Barclays released its annual global exploration and production survey on the 9th of this month showing a decline the in the forward prices for natural gas as natural gas producers with assets in oil production feel the bite of lower cash flow and consolidation of spending on higher yielding acreage will occur across the board.
A low-growth, low-inflation, low-interest rate environment
The speed with which the oil price has crashed goes beyond simply making energy cheaper for consumers.
Net oil importers, such as the Philippines (and many other ASEAN nations) will likely see a boost in demand and positive effect on their economies.
However, in China, this effect will likely be a mere blip. It is clear that the rapid growth achieved over the last three decades is no longer sustainable (although, that is not to say the Chinese economy will collapse, it will still achieve growth at more than 6.5% in 2015) as a laundry list of structural problems increasingly imposes itself.
In the US, the lower than expected inflation rate and uneven employment figures has delayed Yellen’s plan to increase interest rates, likely until the last half of 2015.
However, the greatest risk of rapidly declining oil prices lies in Europe. Draghi despite thrown everything including the kitchen sink at the persistently sluggish European economy may now have to contend with the risk of a deflationary cycle. This will not only be an economy problem, but the political blowback from the long implementation of austerity measures is now starting to manifest. Analysts from around the world are watching the Greek situation closely as anti-austerity party Syriza remains popular in opinion polls. This could be a lead indicator to the fragmentation of the euro zone.
The ASEAN region
Of course, the deflationary pressure weak oil prices have created has meant, in turn, that interest rates are remaining low globally.
How does this affect the ASEAN region including the Philippines? This has led to the highly levered investment in emerging markets, which has partly contributed to the robust growth experienced by some including Indonesia, Vietnam, and subsequently, the Philippines, which has experienced rapid export growth (a region leading 19.7% growth in December). Thailand’s political instability has meant its economy has captured little of this growth. This, of course, magnifies the risk of capital flight, should interest rates rise, particularly in the US, where Yellen has threatened to do so since she became governor of the Federal Reserve.
On the other side, Japan has contracted drastically beyond expectation with the increased sales tax earlier this year leading to a technical recession.
China remains the giant within the region, but with critical overcapacity, a transitioning economy, and issues with capital allocation and hidden debt, economists and government officials that this “new normal” no longer allows China to provide that brute force that has typically propped up the global economy in the past. This week, thousands of investors and fund managers converged on Shanghai to attend UBS’s annual Greater China Conference to greater understand the changing investment environment. According to UBS the Chinese share market has been on an unprecedented bull run, up 32% since November, when the central bank cut lending rates. However, this has been less due to economic fundamentals and more retail investors trying to find a place to park funds. This is part of a continuing an explosion in capital flight out of China as consumer sentiment remains low, which has had a profound impact on some countries (such as the US and Australia), particularly in real-estate.
In the end markets in the ASEAN region continues to be a mixed bag.
While Li & Hungerford continues to be bullish on the domestic economy, it is contingent upon the severity of the less than ideal international market. Keep an eye on interest rate movements in the US should they induce capital flight.
Last year the Philippines stock market was one of the best performing in the region with index growth over 22%. The biggest movers were in the energy, finance and construction sector with strong gains by blue chip stocks such as BDO, Ayala Land (ALI), Universal Robina Corp (URC), GT Capital (GTCAP) and Semirara Mining and Power (SCC). However, with an index wide P/E ratio over 20, despite a bullish outlook on the economy for 2015, it does appear to be over-valued and we do not expect the same gains in 2015. Expect the index to consolidate at around 7300 points throughout the year.
2014/2015 may be the year of disruptive technologies. The democratizing effect of the rapid and accessible Internet manifest over the last decade have created visible effects we are already experiencing. LCCs in the airline industry, the proliferation of blogs, the rise of social media, last year Uber and Snapchat capitalized on the trend, and Facebook, while widely viewed as less than successful was still a tech marvel with an IPO value of US$90 billion. Keep an eye on the same kind of opportunities in tech start-ups in the Philippines, which has been aided by the nexus of expertise created by the diversified growth in the BPO industries, such as Grab-taxi, which has ballooned in popularity in 2014.
In real-estate, the over-capacity in Manila real-estate stock looks to persist with SMDC announcing over P42 billion worth of new developments just yesterday, and an increase of P3 billion in capital expenditure. This despite Collier’s noting other developers taking a more conservative approach to development due to such over-capacity. This may slow the capital gains experienced by both residential and commercial properties, which has outpaced rental yield growth in the last half of 2014.
If you are looking to diversify and enter international markets prudence is the key term. Seek safety, go for non-EU bonds (which are now at unsustainably high prices), and maintain a strong cash position to take advantage of equities should something break.