Jan 29, 2015

Crouching Iron, Falling Oil

The European Central Bank’s president, Mario Draghi, announces a quantitative easing programme on 22 January 2015. Photograph: Horacio Villalobos/Corbis
The global equity markets have been showing much optimism in the past few days after the  the European Central Bank executed a large scale qualitative easing program. The resounding victory by the Greek anti-austerity opposition party did not derail the stock rally as most political observers believe that the leader of the opposition party does not have the political will to force Greece out of  EU. The euphoria of the EU engaging in large scale money printing had the global markets lull into a false sense of security.

All the problems that have been plaguing us in 2013-2014 have not gone away and some of the indicators are, in fact, getting worse. Here are some of the key risks I see ahead:

Falling Oil Prices, Russia & Resource Debt
With the spotlight on EU, investors have conveniently forgotten about the oil prices, which has been trending slowly downwards. The threat of a drastic monetary action by Russia, such as a capital control, is still very much alive, should the low oil prices continue to persist. This will wreck the EU and parts of Asia's Economies.

Other than Oil, other industrial metals such as iron, copper and aluminum have been trending downwards, quietly, in the background. Other than property developers, oil and mining companies traditionally are some of the most leveraged industries in the world and it remains to see if a chain of bankruptcies in the resource industry will lead to a contagion effect like the sub-prime crisis in 2007.

The falling oil and industrial prices mask another real problem: China. With the prices of primary manufacturing materials in free fall, it hints of much more ominous problems with the Chinese economy than suggested by the government. China is one of the primary consumer of these industrial metals since the boom years in 2000s and if commodity prices have been falling so drastically in the past few months, China's economy might be at the brink of a potential financial disaster. Couple that with a bubbly property and stock market and huge internal debt, the Chinese government is treading a fine line trying to maneuver the Chinese Economy into a soft landing.

US and Rising Interest Rates
US is the only bright light in a slowing world economy and the US central bank is poised to raise their interest rates in the 2nd Quarter of the year. The emerging markets such as Turkey, India, Indonesia, Malaysia and Thailand suffered greatly when the US Fed announced an commencement of the tapering of the QE program in 2013. All the problems associated with these countries seem to have disappeared overnight and their stock markets soared to new heights. These problems are still around and we will probably see a resurgent of these issues this year again. Add the threat of a weaker Chinese and Japanese Economy as compared to 2013 and you will see why this will pose a problem when interest rates start to rise in March in anticipation of the interest rates rise.

Given so much threats and risks down the road, I feel it is prudent to scale back at this point of time. We had a good run riding on the October correction adding 6-7% to our portfolio in a short span of 4 months. Moving forward, I will continue to adjust the portfolio base on the development on the ground.

Update: I started writing this investment update on 27th Jan, the US and EU markets tumbled 3% over the next two days. Hopefully, whatever that I predicted do not come to fore so early in the year! 

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