From boom to gloom
February 25th, 2011
A few days ago the investment world was alive to the voices of investment managers urging people to take on more risk. Shares were top of the pops. Developed markets were the place to be. They were putting cash in, and withdrawing money from emerging markets to put it into the US and the other majors.
In recent days the Middle East has turned nastier. The rolling revolution has hit Libya, an oil producing country. That makes investors sit up and take note. The Libyan regime has turned to brutality to try to prop up the dictator’s power. Oil company executives have been waiting at Tripoli airport for planes home. The flow of Libyan oil has been reduced.
It is difficult to say yet whether the Libyan explosion will spread to other oil states. Saudi has already said she could pump enough extra oil for a bit to replace the losses from Libya. Any future government of Libya would presumably be keen to reinstate full oil output, to pay the bills and repair the damage. Libya itself is probably containable. The sky high oil price reflects fears that what is happening today in Libya could happen tomorrow in more oil producing states, including one or more of the large producers. That would be an altogether more serious development for the world economy.
The sudden explosion of oil prices is but the latest in a general inflation that set in some months ago. I have been long saying that 2011 will have two worrying characteristics for investors. It will be the year of rising prices and rising interest rates. We have witnessed a surge in food price inflation. Metals and other basics for industry have risen strongly on the back of higher world demand and an end to the violent destocking of the Credit Crunch. Now energy is kicking in as the main driver of faster inflation.
Some analysts and commentators rightly point out that oil price rises do not have as big a deadening impact on western economies as they used to. These countries are a bit less energy dependent than they were once, partly because so much energy intensive industry has passed to the emerging economies, partly because they have taken some action to be more fuel efficient. The oil price rises will, however, have a negative impact. There will be some reduction in other output as companies and people struggle to pay the inflated bills for power. The substantial impact on consumer price indices will also take Banks and monetary authorities closer to raising interest rates, as they fight to reassure people after another round of price increases has gone through.
So what should an investor do now? It is probably best to recognise that the bull market which started almost two years ago has come a long way in most world markets. Rising interest rates are not good news for longer bonds, so the cash and fixed interest component of a portfolio should be moved shorter. Many will choose to run their shareholding positions on the grounds that the Middle East may pull back from the brink of revolution in the big oil states. Meanwhile corporate profits and cashflows are good in the west, whilst the emerging market economies struggle to slow their growth against a very inflationary background. It does not seem like a good time, however, to be running very large positions in risky assets, and certainly not a good idea to be borrowing to finance such positions. Risk and fear is beginning to stalk the markets, just at the time when the investment consensus was bullish. We have taken some risk off the table for our balanced and general investment funds and are moving bond portfolios with the cash to a shorter average maturity.
