The meeting of 11 major oil exporters in the world (responsible for over 50% of global output) ended without reaching an agreement on a freezing of the oil production. Causing the failure of talks on the freezing output for half a year was Saudi Arabia’s insistence for Iran participation (in order to maintain its market share).
According to Bloomberg reports, they are expected to meet again to discuss the freezing output matter only in June.
In response to the failure of the talks, the prices of oil barrel recorded sharp declines.
Recall that since the beginning of this year, the oil made a remarkable recovery, when the price of Brent crude rose from a low of $27 in January 2016 to around $44 a barrel at the peak (12.4), reflecting a jump of about 60% from its low (1.20).
The bulk correction in oil prices recorded recently, due to nurturing expectations for formulating an agreement to freeze oil production, as well as geopolitical factors (escalation in the Middle East) increasing domestic energy consumption in OPEC, reducing US oil production following a reduction in capital expenditures and the closure of large short positions on the oil by market players.
According to estimates, the slump in oil prices is behind us, although high volatility in the energy market is expected to continue in parallel to the trend of recovery in the price. Although the rapid return to record levels today is not on the agenda, the prices of long-term equilibrium range around $60 a barrel.
The sharp decline in oil prices have a significant effect on the the global economy and on the the financial markets. As in any field, even in this situation there are gainers and losers. When you come to analyze the impact on the global economy it is important to first identify which factors leading to the decline in oil prices – the demand side or supply side. It seems that in the current situation, the impact of supply side is the dominant, as described below.
Generally, one can say that a 10% drop in oil prices raises global growth by 0.3% and detract about 0.3% global inflation.
So why are oil prices going down?
There are several reasons for the sharp decline in prices, but the main reason is probably fear of oversupply, arising mainly from the agreement with Iran combined with growing levels of inventories, on the other hand, concerns about weak demand as a result of the fragile situation in Europe and China adds fuel to the fire.
Iran: According to market estimates, the agreement signed between Iran and the superpowers, which removes the sanctions against Iran and returns it to be main supplier of oil to global markets, may inject millions of barrels a day and thus increase the surplus of supply that exists today.
An increase in supply: lack of freezing production agreement could lead states such as Saudi Arabia and Russia reach their maximum potential of production, in order to maintain the leading position and market share.
China: a slowdown in the world’s second largest economy, raises concerns about weak demand for oil.
Impact on global stock markets – the decline in oil prices has many implications on global stock markets. while, energy and mining sectors are expected to be the main victims of these developments. On the other hand, there are also benefits from the fall in energy prices. This is a significant relief for the American consumer, this will increase his purchasing power, and for the US economy (which is not based solely on the energy sector). Thus, the retail sector, and finance (In some areas) in the United States are expected to benefit from this trend. This, in addition to the airlines sector, which is expected to benefit from a decrease in jet fuel costs, and the automotive sector, which is expected to enjoy a downward trend in fuel prices.
We constantly emphasize that in our assessment, the sensitivity markets remained high, the stocks are expected to stand out positively compared to investment alternatives. Because of the high level of volatility, there is high importance to the balancing and selective choice of sectors and stocks in the portfolios. It is recommended to balance the investment mix by combining cyclical industries stocks, which are expected to benefit from growth, such as technology (QQQ) and Consumer Discretionary (XLY), alongside stocks from defensive industries health (XLV) and consumer staples (XLP). You can also be exposed to value shares, to reduce the level of risk.
As mentioned above, although the energy sector has recently shown some recovery from the low levels. However, it is important to remember that most of the processes that led to the oil price lows are fundamental and are due to an excess supply of oil and natural gas, which is not necessarily expected to close soon. A historical perspective, the processes in the energy and commodity markets are long, and the environment of low oil prices can be with us for some time. Accordingly, in light of the above, and forecast a significant withdrawal profitability of the sector in the coming quarters, the energy sector is not included in the list of sectors recommended by us.
However, for those who want to expose their portfolio the industry, that is considered to be at higher risk, and for those who believe that the oil price has has reached the bottom. it is important to realize that there are great variations between companies and industry exposure through comprehensive device as ETF may turn out to be wrong. Therefore, it is better that exposure to companies will be by means of strength and market leadership, ownership structure that will enable low costs to survive the difficult period while generating cash and create value for investors. These companies are also likely to benefit in the consolidation process have not yet reached their intensity to the energy sector, and may, if occur, lead to a balance between supply and demand in the market and lead to a recovery in oil prices too distant future.