Standard Life Investments

Published Article

Citywire - Hostage to the fortunes of oil and politics


 

In the forecasting game it is perhaps those brave souls who appear on the television every evening to read the weather that deserve the greatest admiration, or pity! Weather patterns in the UK are notoriously difficult to predict. This is also the case in financial markets, as the best made forecasts can be blown off course by the intervention of unexpected forces. Two of the biggest threats in 2015 are likely to be oil and politics.

Oil prices have recently halved, delivering the third largest fall in modern times. While a supply-induced fall in the cost of energy is typically good news (the equivalent of a tax cut for the majority of the world’s households and businesses) the current decline has been greeted with considerable nervousness. This may be because markets are choosing to focus first on the bad news for economies heavily dependent on oil production rather than the good news for global growth, especially consumer spending, which will take a little longer to come through.

However, the interaction between politics and oil lies behind the sharp sell-off in many markets. This is plain to see in the problems facing Russia, but there are more subtle influences at play. Europe, for example, should eventually benefit from cheaper oil, but in the short run the worry is how this price change pushes the area into deflation. Here politics plays a role; although QE (rightly or wrongly) is seen as the solution to the problem, the forthcoming Greek election could imply delays to Draghi’s much heralded programme. Risk aversion rises in such circumstances.

2015 will see other important elections, for example the UK in May and Spain before year end. Based on past experience, UK asset price performance during election years has actually been far from disheartening with equities beating the average annual return between 1978 and 2011 in five of the eight election years, while bonds beat the average return in three cases. More in depth analysis shows that there are no simple rules of thumb about the impact of an election or particular party on investment returns, as the underlying economic and corporate fundamentals remain the key longer term drivers. On this occasion, does the election result in an unstable minority or coalition government, discouraging businesses from investing and encouraging consumers to delay spending? Are the benefits of cheaper oil saved or spent? Investors need to assess the answers to those questions before and after May 7th.

Andrew Milligan, Head of Global Strategy, Standard Life Investments

First published in Citywire Wealth Manager – January 2015