4. Oil prices: Near-term downside risk, year-end upside
Any effort by major oil producers to start withholding supply again is likely to be neutralised by increased supply from North American Shale producers, limiting any upward pressure on prices. There is also a chance – though it’s unlikely – that oil inventories will hit full capacity toward the end of 2016, leading to a fall in prices.
On current trends, our team does not expect the limits of storage capacity to be reached. But there is always the risk that demand will unexpectedly fall short (or that supply will surprise), at which point the only way to clear the excess supply in the physical market for oil is with sharp price declines Given the high exposure to the energy sector in global credit markets (most notably in EM and US high-yield), this downside risk to oil is among our top downside risks to credit and risky assets more generally.
5. Relative value in commodities: OpEx over CapEx
The ‘lower for longer’ theme for commodity prices is expected to continue next year, but with a demand tilt. China’s efforts to rebalance its economy from investment to consumption should reduce demand for capital expenditure commodities (such as steel, cement, and iron ore) much more than it reduces demand for operating expenditure commodities (such as energy and aluminium).
Companies that produce CapEx commodites, which use mining technologies with a high fixed cost and low marginal cost, are unlikely to cut supply as rapidly as in OpEx:
The decision to shut down a mining facility (taking supply off the market) can entail substantial shutdown costs, and these costs can imply a willingness to continue operating even when prices fall below variable operating costs. Though logical, the operating decisions implied by this cost structure imply that a higher level of value destruction is required to remove production capacity from the market.
6. Global savings glut: In reverse
After oil prices nearly tripled in the years after 2005, investors become focused on recycling saved petrodollars – US dollars earned through the export of oil – through the global financial system. The resulting search for yield that these flows fuelled would then would later be blamed by many for the ensuing credit market excesses. This savings glut is now set to reverse given the current subdued price of oil, and this will be bearish for interest rates while reallocating global income from savers to consumers.
7. US equity upside: Limited by the ‘Yellen Call’
Goldman’s economists see limited upside to equities in 2016. The investment bank’s US portfolio strategy team has a price target 2,100 for the S&P 500 – it has hovering just above 2,000 at the moment. Their estimates suggest a “very modest return of five per cent.” Positive growth surprises are likely to be reacted to more agressively by the US Federal Reserve in 2016.
“We also see a risk that the ‘Bernanke put’ will gradually be replaced by the ‘Yellen call’. The ‘Bernanke put’ captured the intuition that when the risks to growth, inflation and market sentiment are skewed to the downside and the Fed has an easing bias, monetary policy reacts aggressively to bad news. Now that these risks have receded, we expect the Fed will shift to an easing bias, implying that monetary policy will likely begin to react more aggressively to good news.”
They did say that stocks in the Eurozone and Japan would be good investments:
“In contrast to the US, Europe and Japan are both further from the full-employment level of GDP. Indeed, the ECB and BoJ still have an aggressive bias, and our Economics teams in Europe and Japan expect more easing in 2016 rather than less. In other words, the Draghi and Kuroda ‘puts’ are still active, which in our view implies more technical support for risky assets in these markets than in the US.”
