Equity Thursday : Wealth Destruction Butterflies

Central bankers are coming out to reassure markets that lower oil prices are good and the markets are listening, ramping the S&P 500 to a new record close of 2074 last night.

Meanwhile budget offices are all working overtime as countries and corporations realise that the lower prices are here to stay and forecasts will all have to be revised and revisited.

It is math.

Top 500 oil and gas companies in the world has about US 5 trillion in market capitalisation currently which has perhaps taken into account the 30% plunge in oil prices so far.

For instance, the largest firm Exxon is down 6% on the year versus the S&P 500 which is up 12%.

Table of Top Global O&G Companies

top oil gas companies

The oil price tumble has also taken on a deflationary theme for the markets which, when coupled with the BoJ QQE and the prospect of ECB QE, has led to a massive rally in bonds and equities that are not oil and gas linked.

This has led to a bifurcation in asset classes – the toxic vs the rest.

Thus it does not matter that the Boko Haram has slaughtered another 150 people in Nigeria or that Nigeria’s top export is oil, Nigerian bonds are still much in favour, trading at a premium price of 103.77 for the 07/2023 maturity, coming off its high of 110.50 back in September. Note that the Nigeria stock market is down 19% year to date.

The rest of the world is not that lucky as we read that “Harold Hamm, one of fracking’s leading cheerleaders and the founder and chief executive officer of Oklahoma City-based Continental Resources Inc., has lost more than $12 billion in three months — half his fortune, according to the Bloomberg Billionaires Index.” https://www.bloomberg.com/news/2014-12-04/biggest-winners-and-unluckiest-losers-of-global-oil-price-crash.html

The truth is that he is not the only one poorer and who has had his wealth destroyed.

The butterfly or domino effect of oil prices will be more pervasive than the current bucket list.

Cost savings to companies and consumers will not immediately translate to 1. increased spending and investment, or 2. higher wages (especially in times of deflation).

In addition, we will have to deal with the oil related investment slow downs as evidenced in the Petronas CEO’s warning to suppliers that “All servicing companies will be impacted by this. Therefore, it is advisable for more consolidations to take place among the players.” There are about 40 listed O&G companies in Malaysia and all depend on Petronas for jobs, not to mention those listed in Singapore. http://www.thestar.com.my/Business/Business-News/2014/11/29/Petronas-cuts-capex-Shamsul-spells-out-the-clear-dangers-of-falling-oil-prices-including-a-cut-in-Pe/?style=biz

And the world will have to deal with the companies and countries that have budgeted wrongly for this scenario and we have a queue coming right up next year in the profit forecasts and bond/loan refinancings.

Another weak link is real estate.

Real estate prices (valuations) and equity markets have created about US 20.1 trillion in global wealth this year according to the Credit Suisse Global Wealth Report.

We cannot have residential real estate prices continue to climb in 2015 when 1. we are expecting deflation or disinflation, 2. governments are phasing in macroprudential measures to cool the markets and 3. real estate demand is tapering off in China, London and more.

Wage growth is slowing although the full effects of oil prices have barely filtered through. Unit labour costs and compensation numbers out of the US last night were hardly cheery, making a tough case for increased spending or investment into real estate.

Checking the spending patterns of the average American family, we can see where most of the expenditures will be going to – rents, anyone ?

The truth is that most industry professionals are quite baffled at what is happening right now as China stocks have rallied about 18% in a fortnight. (Equity portfolio managers are saying it is expectations of a RRR cut in Jan but bond fund managers are seeing no signs of that).

The answer is that it is a trading market because there are no fundamentals involved when tomorrow hangs in a delicate balance on what central banks decide today.

Central banks who are eager to please as governments lose popularity rapidly eg. Australia and Taiwan in the past week, with incumbent parties losing elections, not to mention the US mid terms last month.

Traders know that equity and bond markets will benefit whether the measures work or not, leaving out the oily companies. Fundamental valuations mean little and the people in Malaysia, Nigeria, Norway and Russia probably do not know that they are poorer along with their governments.

All I know is that when an asset depreciates, value is destroyed. A theoretical price may be put on the value gained by users dependent on the asset, but that really remains to be seen.