Brexit deal agreed
UK equities ended the month slightly lower, and Sterling was little changed after Theresa May agreed a Brexit deal with the other EU leaders. The deal was widely expected, and the big question remains whether she will be able to get the deal ratified by the UK Parliament. This seems unlikely, and the likelihood of no deal or a second vote is increasing.
Malaise continues in European equities
Angela Merkel’s domestic political worries, the Italian budget issue and tensions with Hungary, as well as worsening economic data, saw European equities mostly lower in November. Peripheral and emerging markets generally performed well, but the major markets saw falls of 1-2%. Bond yields generally settled and buyers continued to be active in French, German and ECB issues.
Oil stocks down as WTI falls by more than 20%
Oil shares, which feature in many income portfolios, were hit during November as the price of oil fell by 22% during the month. President Trump has been keen to talk down the oil price, urging Saudi Arabia to allow it to go lower. WTI crude peaked at just over $76/barrel in October, but since then, has reached just $50, as producers have relaxed supply curbs to counteract the renewed sanctions on Iran.
Emerging Markets rally on G20 optimism
The G20 meeting at the end of the month was widely anticipated and saw President Trump and Xi Jinping meet face to face, with the result that the US agreed to suspend additional tariffs for 90 days to allow negotiations on a trade deal. Emerging markets rose and the Dollar fell by almost 2% against the Yuan.
The World at a Glance
Source: Bloomberg, Trading Economics
During November, the North American markets continued to move ahead, though less aggressively than earlier in the year. Japan also saw a modest gain, with the UK and EU returning losses. Overall, the best performers were the emerging markets, in a reversal of October’s performance, and gains were seen across all continents, as the Dollar paused after its strong performance in 2018. The best return overall came from Turkey, which rose by 12.9% in Sterling terms, whilst India and China also rebounded strongly.
European markets extended their losses from October, although falls were mostly more muted. Returns from the major European markets were mostly small single digit losses, ranging from -2.0% in Germany, through to +2.1% from Belgium. Emerging and peripheral European markets fared much better on the whole, with Turkey, Poland and Hungary all seeing strong positive returns. German political uncertainty, riots in Paris and, to a lesser extent, Brexit, all weighed heavily on the EU, whilst UK equities fell by a further 1.9% as the Prime Minister faced the prospect of her Brexit deal being rejected by Parliament.
Sterling was volatile again in November, as Mrs May agreed a Brexit deal with the EU, but faced a growing crisis of confidence in the UK, as Parliament seemed set to reject the deal, leaving open the possibility of a no-deal Brexit. A reasonable mid-term election performance saw the Republicans lose control of the House, but retain the Senate, much as expected, allowing President Trump to claim a good result, and the Dollar remained steady. The Chinese Yuan gained some ground against western currencies as there was no further escalation in the tariff war with the US.
The flight to safety in Europe saw a continuation of the trend in previous months, as investors moved into French, German and ECB bonds. Italy and Spain also saw their bond yields reduce slightly during the month with the yield on Greek bonds edging slightly higher. US bond yields ticked lower, leading some sensationalizing commentators to predict a full inversion of the yield curve and imminent recession, though the economic data does not support this. Buying support continued for UK debt, as the outlook for rate rises remained weak amid the Brexit-related uncertainty.
*A Generic bond is a theoretical bond that always has the specified tenor, unlike a Benchmark bond, which is a physical bond, with a decreasing tenor.
The Oil Price's Remarkable Reversal
In a world where many investors have been searching for the positives, the recent remarkable reversal of oil prices offers some good news at least for some investments. The critical question is whether the weakness in oil prices is sustainable. We suspect they are.
One of the remarkable turnarounds in recent months has been the fall from grace of the oil price. From the lofty heights of US$86.74 when oil was up 30%, oil is now in a bear market. At the beginning of October, Brent Crude, the leading price benchmark for over two-thirds of the world’s internationally traded crude oil supplies, hit a near four year high. However, by November WTI oil prices have fallen by more than 30% from their peak.
Chart 1: WTI Oil Price
The source of price weakness is multi-faceted.
OPEC now a price influencer, not a price setter.
OPEC no longer has control of a market it used to dominate. OPEC now faces the requirement in their December meeting to think about the need for production cuts. Such cuts would represent yet another reversal of policy. Remember it was only recently that OPEC was under pressure from President Trump to increase production to bring prices down.
Maybe more disconcerting for the oil markets have been mutterings from analysts of a potential break up of OPEC. Indeed, Saudi Arabia even admitted recently that it had asked one of its think tanks to study the possible effects on oil markets of a break up of OPEC. OPEC’s concerns relate to legal opinions in the United States that OPEC might be deemed to be acting as an illegal monopoly and be subject to anti-trust investigation. A few months back the OPEC President wrote to all members asking them to desist from talking about the level of oil prices per se and only allude to the need to minimise the volatility of oil prices. Qatar’s recent decision to quit OPEC only adds to this sense of failing cohesion.
US production continues to climb
The expansion of US oil production has challenged the omnipotence of OPEC’s supremacy in the oil market. US crude oil production has risen to a new peak as shale oil output has continued to climb and the US is now the worlds’ largest producer of crude oil. Also, there are signs that some of the pipeline bottle-necks are starting to be relieved with more pipelines due to come on-line in early 2019. The focus on the crude oil production numbers ignores the steady growth in the US of other sources of oil supply, such as NGL (Natural Gas Liquids), a by-product of shale gas output. This is further additional US oil supply into an already oversupplied market.
Chart 2: US Oil Output Still Rising
Diluted sanctions pose less of a challenge to supply
Although President Trump has talked a tough story on Iranian sanctions, the actual implementation has been relatively muted. Crucially, several countries including India, Italy, Japan, Turkey and South Korea, received temporary six-month waivers allowing them to continue to import Iranian oil. The prospect of a sudden collapse of Iranian export volumes has now evaporated.
Positive consequences of the fall in oil price
There have been some immediate winners from the fall in oil prices. Firstly, India as a major oil importer. Delhi petrol pump prices, for example, have fallen 14% in 8 weeks, much to the relief of the local population. Indian asset markets and the rupee have recovered sharply from previous losses. The threat of rises in interest rates to control inflation has abated. Also, some of the political pressure on the government has eased lifting hopes of a win for Narendra Modi in next year’s general election.
Gasoline prices below US$2 at the pump will be of great benefit to the US consumer, as it simply translates into more dollars in the pocket to spend during the festive break. However, the dramatic fall in the WTI price has led to worries in the US high yield bond market, as creditors become concerned about the ability of overleveraged oil fracking companies to repay their debts. The future stability of these companies, in turn, threatens to put jobs at risk and sours local business activity and sentiment.
The fall in the oil price also appears to have taken off some of the pressure for further increases in US interest rates. Although the Fed tries to look through fluctuations in commodity prices and its impact on headline inflation the previous spike had the potential to only reinforce some of the inflationary pressures that had led the Fed to signal they were minded to increasing rates by a further 75bps over the coming 15 months. The sheer size of the US onshore drilling industry and its supply base means that from a total economy perspective, falling oil prices are now more of a mixed blessing.