Higher interest rates and sharply rising oil prices have been instrumental in leading to a slowdown ...
Higher interest rates and sharply rising oil prices have been instrumental in leading to a slowdown in world economic activity.
In addition, the sell-off in technology stocks indicates a cooling in IT spend from the heady rates of recent years, further dampening economic growth. There is a risk that this confluence of events could prove recessionary.
However, we remain of the view that this can be avoided, that we are still in the "mini-cycle" environment of low amplitude volatility in growth and inflation.
While this assessment of the macro environment is relatively benign, the combination of short-term factors, slowing growth and increasing energy costs, coupled with longer-term trends of competitiveness, pricing power and business expenditure on IT is leading to a much more difficult period for corporate profits.
However, in financial markets this may already be partially discounted, with equities under pressure for most of this year. Indeed, it can be argued that much of the market, particularly the old economy stocks has been in a bear phase for the past 12 months.
Investor concerns over the current price of oil are rational, in that previous oil price spikes have been associated with recessions.
This outcome is not inevitable this time for several reasons: The real (ie inflation adjusted) price of oil is currently no where near as high as was reached in the 70s or early 90s; developed economies are much less oil intensive than in the past and perhaps, most importantly, the inflationary mechanism, which quickly translates an increased energy cost into higher wages and product prices in the wider economy, is much less prevalent in today's hyper-competitive world.
With regard to the oil price our view is that $35 oil is as unsustainable as $12 oil (only 18 months ago). With supply of crude oil exceeding demand, inventories are building and prices should drift back to the $20-25 range. The industry is, however, operating at high levels of utilisation and there is a risk that the Northern Hemisphere winter demand could see the price spike to $40-$50 for a short period.
On the above analysis, current interest rates are at, or close to, their peaks. But in the short term, we lack the catalyst for falling rates with the economic data not yet sufficiently weak. Moreover, politically driven fiscal easing and the spectre of sustained higher oil prices (during the Northern Hemisphere winter) could keep rates at current levels for longer.
In investment terms, the current environment favours the defensive sectors over cyclicals and technology. This is contrary to our longer-term views, which are much more individual stock selection orientated and cut across sectors.
Robert Shelton is a fund manager of the Newton Managed Fund
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