Asia/Pacific: Bursting of Oil Bubble Revives Growth Expectations by Morgan Stanley

Asia/Pacific: Bursting of Oil Bubble Revives Growth Expectations

Andy Xie (Hong Kong)

Summary and Investment Conclusion

The growth scare of October may be behind us.  The decline in oil prices is reviving growth expectations.   I believe that the oil price could drop below US$40/bbl in the coming months.  This would be good news, especially for Asia.

The current round of growth optimism may last six months.  Two factors could cause growth expectations to turn down by mid-2006: (1) the tightening by major central banks could start to bite by that time; and (2) the property bubble has already begun to deflate in China and the US, which could become a major headwind for growth by the middle of next year.

The Oil Bubble May Be Deflating

The price of Brent crude dropped by 9% last week and is off by 18% from the peak in early September.  Oil may be the first bubble to burst in the current cycle.   If so, the price could drop below US$40/bbl in the coming months.

Oil is a bubble, I believe.  The supply-demand balance is not as tight in 2005 as it was in 2004.   Despite the recent correction, oil prices are still 50% above the averages in 2004.  It is demand from financial buyers that has kept oil prices so high, in my opinion.

According to the IEA, global oil demand rose by 2.9 million bbl/day or 3.7% in 2004.  Growth in 2004 was twice as high as the historical average mainly because of a 15% increase in Chinese demand.   The market thought that the trend in Chinese demand growth had permanently changed and sharply pushed up oil prices this year. 

I thought that the growth in Chinese demand at twice as fast as previously last year was due to the economy overheating and bottlenecks in electricity generation, which led to the widespread use of diesel generators.   As capacity for the generation of electricity has increased at a faster rate than demand this year, the use of oil products for electricity production has declined sharply.  This is why China's demand for crude and oil products has remained flat despite rapid economic growth.

Despite evidence of plentiful oil supply, the market has kept pushing oil prices higher and higher on any excuse.   It looked to me like financial mania.  Low interest rates and anemic returns in stock market were the catalysts in triggering speculation in oil.  The momentum sucked in more and more speculators.   The bubble is finally crumbling under its own weight as there are not enough new speculators to sustain the upward momentum.

Oil supply could be even more abundant in 2006.  The IEA forecasts production capacity rising by 2.5 million bbl/day next year.   I suspect that demand will grow by less than 1.5 million bbl/day.  Rising interest rates and a supply glut in 2006 create the environment for an oil price collapse, in my view.  The oil prices could drop below US$40/bbl in the coming months, I estimate.

AsiaBenefits Most from Declining Oil Prices

Asia excluding Japan accounts for 10% of global GDP but 20% of oil demand.  When oil prices decline, as they are doing now, the region should benefit substantially.  If Brent crude were to average US$40/bbl next year versus US$54/bbl this year, the region's oil import bill could be down by US$51 billion or 1.2% of GDP.

The overall benefit from the declining oil price in the above scenario is similar to a 5% increase in the region's exports.   Since the region's exports are growing three times as fast as that now, the fluctuation in oil prices is certainly less important than global trade momentum.  However, this benefit could offset som e US consumption weakness in the first half of 2006.

The distribution of the benefits from lower oil prices could be counterintuitive.  Because China has benefited so much from the increased purchasing power of oil exporters (see Diverse Effects of Expensive Oil, November 7, 2005), the benefit of low oil prices for China could be offset by lower export income to oil exporting economies.

One major benefit from a fall in oil prices is less inflationary pressure.  Indonesia and Thailand have been hit particularly hard in that regard.  Both have had to increase interest rates rapidly to contain inflationary pressure.  A drop in oil prices would give them much needed flexibility in monetary policy.

Growth Momentum Could Slacken by Mid-2006

Declining oil prices could be the last significant stimulus for growth in this economic cycle.  However, growth headwinds are intensifying in the global economy.   As soon as the stimulus from declining oil prices is exhausted, the current business cycle could turn down decisively.

The most important headwind for growth is the deflating of the property bubble almost everywhere.  Because interest rates are still low despite the 12 Fed rate hikes, property deflation seems to be at a slow pace, which is not yet alarming financial markets.   I think the situation will be quite different by mid-2006.

First, the slow-motion deflation of a property bubble will bite over time in any case.  There should be enough time to convince property owners that they are holding a depreciating asset by mid-2006, which would change their consumption behavior.   The consumption momentum in the US could turn sluggish.

China's property bubble is beginning to deflate.  While construction is still rising rapidly despite sluggish sales, it should slow or even decline by mid-2006 as inventories pile up.  The slowing trend could accelerate by then, which could bring down China's investment growth rate sharply.

Second, global liquidity should begin to decline by that time.  The Fed rate hikes have had a limited effect on global liquidity because financial markets can tap into the plentiful liquidity in Europe and Japan.   One by-product of this trend is the decline in the euro and the yen.  The availability of alternative sources of liquidity has reduced the effectiveness of the Fed rate hikes.

As the dollar strengthens, the effectiveness of alternative liquidity will decline and global liquidity tighten.   Furthermore, by all indications, the ECB and BoJ should have begun to tighten by mid-2006.  Global liquidity could drop sharply by that time.  This could cause the risk appetite in the world to decline significantly.

The rise in risk appetite in financial markets has been at the heart of the global economic resilience in recent years.   The proliferation of innovative mortgage products, hedge funds, private equity, and Wall Street proprietary trading has sharply decreased the cost of capital for physical investment or financial speculation.   

There has been a close correlation between the increase in risk appetite and decline in interest rates, making monetary policy more potent than usual in this cycle.   This has been the principal reason for the numerous bubbles that have elevated global growth.  As monetary conditions reverse, the risk appetite may reverse also.   Many financial bubbles could deflate in 2006, bringing down the global growth rate.

-- DISCLAIMER --
The information and statistical data herein have been obtained from sources I believe to be reliable but in no way are warranted by me as to accuracy or completeness.
I do not undertake to advise you as to any change of my views and I may hold securities which are recommended here.
This is not a solicitation or any offer to buy or sell.
All information and advice is given in good faith but without any warranty.

How Do I Know if I Should Buy, Sell or Hold?

How Do I Know if I Should Buy, Sell or Hold?

"Buy low, sell high" is a favorite quip uttered by actors playing Wall Street tycoons in movies. It would be great if we could know that when we buy a stock it is low in price and that we will be certain to make a killing later when we sell it. Unfortunately, such knowledge is impossible to come by.

 

When people talk about buying, selling and holding, they are really talking about two different things: whether they should buy, sell or hold classes of assets, such as stocks, bonds and cash; and whether they should buy, sell or hold stocks or bonds of individual companies.

 

Buying, Selling and Holding Asset Classes

When investors buy, sell or hold, asset classes, such a decision should be part of a long-term and focused financial plan. For example, a young couple decide that they want to fund their child's higher education, they would figure out how much they could afford to invest each year or month. Generally, such couples may put the majority of the funds into stocks or stock funds because stocks generate the highest returns relative to other investments, such as bonds or cash. If the child is, say, two, they may be investing, or buying regularly in stocks or stock mutual funds, for example, buying $200 worth of stock each month, based, of course, on their income and whether they want to send their child to a private or public university. They may be buying and holding stocks until the child reaches the ages of 13 or 14.

 

At that point, with only four or five years before they need to pay tuition, they may be gradually selling some of their stocks and moving into medium-term bonds or bond funds, which are less volatile than stocks. In effect, the couple is reducing the risk that their stock market gains could be hurt by a sudden downturn in prices.

 

By the time the child is in college, they may have sold all their stock and have their proceeds in a combination of cash and short-term, high quality bonds, such as government bonds, in order to make sure that they can indeed pay the expense.

 

Clearly then when buying, selling and holding asset classes, the key driver is achieving the long-term financial goal.

 

Buying, Selling and Holding Individual Stocks

Figuring out when to buy, sell and hold individual stocks is much harder to determine. In general, financial professionals advise a long-term buy and hold approach, meaning that investors should carefully research companies they are interested in investing in and once they buy them, hold them for at least 10 years or more.

 

Many studies have shown that when investors try to time the market, that is guess when a stock is low or high and try to make a profit on the difference, they bet wrong. Another problem with buying and selling stocks quickly is transaction costs. In other words, even if there was a way to time the market and make a profit, costs such as broker commissions, taxes, etc. would eat away at those gains.

 

Many investment philosophies offer general rules when to buy, sell and hold. For example, value investing suggests buying companies when their price-earnings ratio is below that of the market as a whole and their competitors. If and when the company's price-earnings ratio rises above the market as a whole and its competitors, than that company is considered to be overvalued, and an investor should consider selling it and taking profits.

 

Some investors overreact to bad news about their companies and drops in their share prices. They think to themselves "everyone's dumping this stock, I should too." That may be a mistake. Investors need to analyze and decide for themselves whether a company that is seeing its share price drop really is in trouble, or is just having a minor setback.

 

That is no easy thing to decide. Some investors, in fact, talk themselves into believing that a company and its stock price will recover when in fact, the company will likely go under. These investors don't want to admit to themselves that they will incur losses and ride the stock down to the very end.

 

To reduce the tendency to react emotionally to changes in share prices, investors need to remain calm and collected and rely on the facts, as outlined in corporate earnings reports, news articles, etc. Another way to remain calm is to talk about your investments with a financial professional or join an investment club, where you'll get a variety of opinions on what you should do. 

30 Stupid Reasons to Invest! From Bob Singh

Have you not heard all of this? If not mail me, I will make a list of when and where, and how many times these reasons were given. :-)

From Rediff
Stupidest reasons to buy stocks
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1. It will double in 2 years. (Sensex at 6500).
2. It will double in 1 year. (Sensex at 7000).
3. It will double in 6 months. (Sensex at 7500).
4. It will double in 3 months. (Sensex at 8000).
5. It will double in 1 month. (Sensex at 8500).
6. Company is doing a private placement/FCCB.
7. Company is going to give a bonus issue.
8. Company is going for a stock split.
9. Debt restructuring package.
10. Low PE. (What does it mean, isn't it because the company has no earnings?).
11. Looks good on the chart.
12. Company has got a big order.
13. They are planning an expansion.
14. Company has won some order from China.
15. Wal-Mart is outsourcing.
16. Market will go to 15,000.
17. Rakesh Jhunjunwalla (a leading Indian stock broker) is buying.
18. Warren Buffett is buying.
19. Reliance Capital is buying.
20. A big operator is buying.
21. Fidelity is buying.
22. Japanese are buying.
23. Some fund is buying.
24. The research analyst said it's undervalued. (Analyst know nothing. Period.)
25. They have lots of property.
26. Company is going for a buyback.
27. RSI is low.
28. Good story.
29. It's a long-term secular bull market.
30. My broker says it's a good buy.

Reason No. 31. Good reports are pouring (Not in Rediff story)