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LGT: Don’t believe the doomsayers, low oil is a plus

Energy stocks may start to look interesting this year, says LGT Bank’s chief investment strategist Stephen Corry, who has some positive views on 2016.

Corry said he can’t figure out why the falling price of oil is such an issue with many investors.

“Oil declines in a disorderly manner and maybe that’s upsetting markets. At the end of the day, lower oil prices are good for the global economy.

“I read articles that say oil prices are low because of weaker demand. That’s not happening. Oil demand has the second strongest rate of growth in over a decade. The reason oil is cheap is because of oversupply.”

When lower oil prices come from oversupply, it has proven to be beneficial to economic growth, he said. Cheap oil tends to benefit lower income groups, which they spend on gas and utilities.

“That hasn’t materialized yet. We haven’t seen the benefits yet to the economies of the US, Europe or Japan and markets are taking this negatively.”

The good news, according to Corry, is that oil supply will likely tighten this year.

The current oversupply is driven by Saudi Arabia’s reluctance to cut production, which is due to geopolitical reasons. He believes that mounting pressure on Saudi finances will lead to a production cut in the second half of the year.

“Saudi Arabia has excess reserves and assets but its fiscal deficit is 20% of GDP per annum and its finances will deteriorate sizably,” he said, adding that recently authorities announced a ban on the sale of Saudi riyal forwards because lower oil increased the pressure on the currency. In addition, the cost of Saudi credit default swaps, which are basically insurance against bankruptcy, have soared.

“What is the easier option if pressures continue – let the currency go or cut oil production and let prices go higher? I believe they will cut production in the second half of 2016.

“Oil prices will find a floor and rise and at some point energy stocks will look very interesting.”

In the short run, lower oil is a negative, Corry explained. “It ultimately means lower capex spending on projects and job losses in the energy sector. At some point, this will turn positive. If you look at consumer confidence indices and retail sales, typically in the past low oil prices have been a huge stimulus to developed economies.”

Bear market 2016?

Corry mentioned two data indicators that suggest the downward trend in global markets in January is not structural but superficial.

“Bear markets tend not to occur unless there is an economic recession, which doesn’t occur unless there are economic imbalances, and we don’t see any.”

He mentions data that examined all 14 bear markets for the last 70 years to search for warning sings. Eleven of the 14 bear markets were linked to the slope of US Treasury yields. When investors became negative, an economic recession developed.

“It’s a reliable indicator. The good news is that even though it has flattened a bit it is still positive. If it does go negative that would change our outlook on the S&P 500.”

A supporting data point is the Merrill Lynch global fund manager’s survey, which measures cash levels fund managers are running. High cash levels are an indication of market pessimism and low levels indicate euphoria, Corry explained.

“In 2007, cash levels less than 3.5% indicated it was time to sell equities. During the Lehman crisis, it rose to 5.5% as an indication to buy. Today’s reading is 5.4%.

“That’s a contrarian buy signal because investors are running high cash levels and expressing pessimism. That suggests any weakness in global equities will be shallow in nature.”

Part of the Mark Allen Group.