Today the market has been up and sideways basically, perhaps a little more defensive this afternoon,...
What happens after Libya? And how will it move stocks?
03/04/2011 8:30 am EST
No, no, it really is.
Libya isn’t Egypt and the effects on the stock market this time will be different from the effects of the earlier crisis.
Different enough, in my opinion, that you need to factor them into your investment strategy. But not so different that you need to tear up all your investing plans for 2011.
The short-term effects don’t look that all that different, I admit. Especially if you look just a developed economy stock market like that in the United States.
Egypt, as scary and exciting (and important, especially for Egyptians) as it was at the time created, barely a ripple in the U.S. stock markets. On January 25, the “Day of Rage,” the Standard & Poor’s 500 stock index closed at 1291. On January 28, the biggest drop during the crises, the index closed at 1276. By January 31, the day when 250,000 protesters gathered in Tahrir Square, the index was back to 1286. By the day of Hosni Mubarak’s resignation the index had climbed to 1329.
The Libyan crisis is already longer than the Egyptian crisis. Demonstrations began on February 15 in Benghazi and the Libyan crisis was in Day 17 as of March 4. The Egyptian crisis from January 25 “Day of Rage” to Mubarak’s resignation ran for just 17 days.
At this point U.S. stock market reaction to the Libyan crisis isn’t a whole lot bigger. The U.S. S&P 500 closed at 1328 on the day of the Benghazi protests, fell to 1306 on the February 17 “Day of Rage” demonstrations, rallied, and then fell on March 1 to 1306 again. It rallied to 1331 yesterday as good economic news from the United States overwhelmed reports of continued fighting in Libya. (See my post http://jubakpicks.com/2011/03/03/dont-worry-be-happy/ )
If you want to see “different,” you have to look at oil prices.Oil traded at $89.11 a barrel on the New York Mercantile Exchange on January 21, 2011, just before the start of the Egyptian crisis. It traded for $89.03 on February 4, a week before Mubarak resigned.
In the case of the Libyan crisis oil traded at $86.20 on February 18, a few days after the initial Benghazi protests. On March 3 the price in New York was over $100 a barrel at $101.87.
Stands to reason. Egypt isn’t a major oil exporter—the country actually has to import oil to meet its domestic needs—even as it is increasing its production of natural gas. Libya is the world’s #12 oil exporter with exports of 1.6 million barrels a day. And that production is especially hard to replace because Libya is a major source of light, sweet crude that’s easy for the world’s refineries to handle. Saudi Arabia would have no problem right now in ramping up production to meet any shortfall from Libya since the Saudis have about 4 million barrels a day in excess capacity. But much of that oil would be heavy, sour grades that are harder to refine.
The differences between the two countries also argue for a difference in how oil will behave when the crisis is over.
In the case of Egypt, any spike in oil prices was only justified if you believed that the crisis would endanger the flow of the 4 million barrels of oil a day that flow through the Suez Canal and a major pipeline that runs towards Europe. Take out that supply route and you’ve got a shortfall that equals the Saudi’s total excess oil capacity. When the crisis ended and the canal and pipeline were clearly still intact, there was no reason for oil not to drop back to its former price.
In the case of Libya, any spike in prices has well-founded worries about damage to the oil fields, the shutdown of pipelines and terminals, and flight of the experienced engineers behind it. It sure doesn’t calm nerves when Muammar Gaddafi threatens to blow up the country’s oil fields—especially when he’s clearly capable of just about anything. Reports out of Libya testify to falling production during the crisis. For example, the state-owned National Oil Company of Libya, which normally pumps about 420,000 barrels a day, said that production had dropped to 100,000 barrels a day.
No one knows how much damage has been done to oil fields and transportation systems and no one will know until the war between Gaddafi and the protesters is over. That nervousness will add to oil prices but I expect that the end of hostilities will show that damage is less than is feared right now.
But I don’t expect oil prices to drop back immediately to their pre-crisis levels as they did after Egypt. No one expected that protesters in Libya stood a chance of toppling the Gaddafi regime. There was no organized opposition and Gaddafi had kept the army splintered so that it couldn’t offer the kind of alternative institutional power that pushed Mubarak out the door in Egypt. And this was one of the world’s most oppressive and brutal regimes with no apparent compunction about using any measure of force against its opponents. It was hard to imagine that protesters could put it on the ropes.
And if Gaddafi falls when everyone thought it was so unlikely, then what regime is not in play?
Iran? The regime looked to have closed potential rifts between President Mahmoud Ahmadinejad and Supreme Leader Ayatollah Ali Khamenei, and to have pushed the opposition into quiet, but the arrest of opposition leaders and their families has produced rage in the streets of Tehran. It is possible again to imagine the fall of this regime. Iran is the No. 4 global oil exporter at about 2.4 million barrels a day.
Saudi Arabia? The Saudis have clearly been unnerved by the protests in neighboring Bahrain, where a Sunni ruling family governs a restive Shia majority. Much of Saudi Arabia’s oil comes from the country’s eastern province with its Shia minority. On March 1 global oil markets were roiled by news that Saudi authorities had detained a Shia cleric in the eastern province after he called for a constitutional monarchy in the country. Saudi Arabia is the big prize among oil producers since it exports 7.3 million barrels of oil a day and manages the world’s excess production capacity. There simply is no way to replace Saudi production.
I think all these post-Libya fears are enough to keep oil higher post-Libya. But the question is how much higher. Figuring out how different the Libyan crisis is depends on your answer to that question.
Oil prices were on a steady climb in 2010 even before either the Egyptian or Libyan crises. Oil traded in New York at $75 a barrel on September 3, at $87 on November 5, and $91 the end of December. That’s quite a move when you consider that oil was trading at just $37 a barrel in January 2009.
The pre-crisis price increase had everything to do with the recovery from the global recession that had depressed demand. That recovery continues—all the talk about slowing growth in the United States or China or India is about slower growth but still growth. The International Energy Agency, reports that oil global oil demand climbed by 2.8 million barrels a day in 2010, and projects another increase of 1.5 million barrels a day in 2011.
Even without worries about Libya, Iran, and Saudi Arabia, oil prices aren’t going down in 2011.
Which wouldn’t be quite so big a deal except for where oil prices have come from and where the world is in its fight against inflation.
A rule of thumb is that every $20 increase in the price of a barrel of oil whacks 2 percentage points off GDP growth over the following two years. Well, the world already had its $20 increase from January 2009 ($36 a barrel) to $57 a barrel in May 2009 and then again to $75 a barrel in September 2010.
Those earlier increases probably didn’t matter a whole lot because the world was crawling out of a deep recession and global demand was still very low.
But now we’re looking at a potential third $20 a barrel increase from $75 to $95 and this one is going to hurt. But it’s not going to hurt evenly over the globe. It’s going to hit oil-importing economies harder than oil exporters. So Turkey is going to feel more pain than Canada. It’s going to hit economies that use energy inefficiently harder than those that are relatively efficient. India, for example, according to the Indian government’s own “India Hydrocarbon Vision—2025” report is going to take a hit to growth because in India it takes 1.1% more oil to add 1% to GDP. That’s high in comparison to developed economies—most developing economies use energy less efficiently than most developed economies—but also in comparison to developing economy competitors such as China.
And this latest potential $20 increase in the price of oil couldn’t come at a much worse time for countries already deep in fighting inflation. Higher oil prices feed into higher inflation—requiring governments to act more forcefully to raise interest rates to lower growth—at the same time as higher oil prices are themselves acting to lower growth rates. That leaves many governments trapped between a rock and a hard place and many will, I assume from past observation of politicians, decide to opt for waiting to do something painful until they see it to be absolutely necessary.
I think that really raises the danger that countries such as India, Turkey, and China that are already on the brink of losing control of inflation will wait too long. And then they will have to take more drastic action to get inflation back under control.
The other danger is to economies with already low growth rates where inflation is pushing up against central bank targets. Here, and the European Union is the best (or worst) example, the danger is that the central bank will feel compelled to raise interest rates and that higher than expected energy prices will push these economies back into a near recession.
Higher oil prices certainly don’t make the world an easier place to invest.
I’d still favor the United States in the first half of 2011 because inflation is currently so low and growth has decent momentum. (What happens in the second half is a different story.)
Higher oil prices also suggest a deeper look at Japan, one of the world’s most efficient energy consumers. The best Japanese exporters actually get some advantage from higher energy prices against less energy-efficient competitors in other economies.
And among emerging markets I’d favor countries that don’t face huge odds against winning their inflation battles, that have central banks that are reasonably tough on inflation, that are energy producers (even if not oil producers), and that have decent economic momentum. Three emerging countries that come to mind are Brazil, Columbia and Poland. (I know that they’re not emerging economies but in the developed world Australia and Canada also fit this profile.)
I’d stick with my suggested overweighting of the United States in the first half of the year and then look at the countries directly above in the second half.
Assuming, of course, that none of our worst fears about the world’s oil producers come true.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. For a full list of the stocks in the fund as of the end of January see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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