Market Views: Where to invest amid record oil prices?

Russia-Ukraine tensions and rising fossil fuel prices add to investors’ portfolio concerns, all amid an inflationary environment.
Market Views: Where to invest amid record oil prices?

Oil prices have soared in recent months, driven by a growing supply and demand imbalance as well as heightened geopolitical risks.

The price for a barrel of Brent had increased by 50% in 2021, and by another 20% since the beginning of this year. On Wednesday, dated Brent reached $100.8 a barrel for the first time since 2014.

Energy price increases over the past 12 months as well as the currently high rates have raised concerns for investors. While the economy is expected to slow down, inflation will continue to fuel higher costs.

Russia-Ukraine tensions have also added to the worries. Russia is the world’s leading exporter of natural gas (17.1% of global production), and the second-largest exporter of crude oil (12.1%) after Saudi Arabia (12.5%).  

Despite Russia reporting that some of its troops have pulled back from the border, diffusing an imminent crisis, the market still expects volatility given that neither side is likely to yield on key objectives.

This week, AsianInvestor dived into asset managers’ asset allocation strategies amid rising oil prices and inflationary pressure.

The following responses have been edited for brevity and clarity.

Subash Pillai, Regional Head of Client Investment Solutions APAC
Franklin Templeton

Subash Pillai

Fund managers are significantly overweight asset classes that do best when oil prices rise, such as commodities, and underweight those vulnerable to higher oil prices, for example bonds. Within equities, allocations to energy stocks are near historical highs. This suggests the balance of risks is for crowded positions to unwind if oil prices soften. This could be driven by reduced geopolitical tensions, a nascent supply response, or softer demand.

We’ve already seen signs that energy inflation is eroding consumer purchasing power, confidence, and spending, especially for commodity-intensive supply-constrained goods. Tightening by central banks could exacerbate this slowdown and increase the uncertainty that’s recently supported commodity prices.

Our asset allocation strategy revolves around our expectation for more volatility throughout 2022 and we advocate being nimble in cross-asset allocation. Within asset classes, we have some positions that hedge against further increases in energy prices. We are presently overweight equities and underweight duration. Within fixed income, we prefer credit sectors that have lower duration, such as high yield over investment grade. We have also reduced our exposure to European equities, as they are most exposed to the Russian and Ukraine conflict and higher energy prices.

Tai Hui, Chief Asia Market Strategist
JP Morgan Asset Management

Tai Hui

While US oil production growth and potential breakthrough in the Iran nuclear deal could provide some relief to the oil market, the underlying demand and supply dynamics should still support energy prices at least for the first half of 2022. A further escalation of tension in Europe would bring a sharp spike in energy and broader commodity prices.

Higher energy costs would benefit energy and commodity sectors in the near term. This is particularly important as the broader equity market is re-assessing monetary policy outlook by the US Federal Reserve and other developed market central banks.

Rising interest rates could create a greater divergence in performance in value and growth sectors. Higher energy costs could also act as a catalyst for governments to invest more in renewable energy and reduce their dependence on fossil fuels.

For fixed income, the energy sector in the corporate high yield market has already outperformed in 2021, but high energy prices could provide more room for spread compression, adding to potential total return.

David Chao, Global Market Strategist, APAC ex Japan

David Chao

Geopolitics will be the main driver for energy prices in 2022, though I think prices will remain elevated due to continued strong demand from economies opening up and tight supplies due to produce’s under-investing over the past few years.

High energy prices could lead to sustained inflationary pressures in places like the US, which could force the Fed to tighten monetary policy more quickly – leading to higher bond yields, a stronger US dollar, equity market fluctuation, and a stronger pivot from growth to value.

Higher energy prices could also dent consumer appetite and spending in places like the US and Europe, which could cause consumer services and discretionary sectors to underperform. Most emerging market Asian countries are net energy importers and so far, many Asian central banks have maintained loose monetary policies and policy rates. If energy prices remain elevated, it’s possible that this translates into greater inflationary pressures for the region and could also force Asian central banks to tighten preemptively, which would adversely impact many nascent Asian economies’ rebound, pressure currencies and local currency bonds.

Although China is a net importer of energy, the country has already implemented policies to clamp down on certain commodity prices and to boost oil reserves. The government also has deep pockets to roll out fuel subsidies for consumers. Still, China continues to see elevated producer prices from high commodity and energy prices, and it bears watching if this trend will continue for a while longer.

Sean Taylor, CIO APAC

Sean Taylor

We believe that energy prices have already seen the bulk of price increases. Will we see a continuation of these price dynamics? We don’t think so. For one, the current price certainly incorporates a risk premium related to the Russian-Ukrainian dispute of maybe some $5 a barrel. While we do not believe this crisis to escalate significantly further, it might drag for some more time and accordingly spook markets for some more time — weeks, maybe months.

In fact, on a 12-month horizon, we expect the oil price to retreat significantly to around $70 a barrel. This is arguably more aggressive than market expectations, as the March 2023 Brent future is currently trading above $80 a barrel on Wednesday. However, this still calls for falling prices. One should not forget that Organization of the Petroleum Exporting Countries (OPEC) generally tries to avoid too hefty price spikes, as this can entail demand cuts and increased efforts by consumers to substitute oil with alternative energy sources.

So, as we believe that energy prices will stabilise and eventually retreat over the course of the year, we see no need to adjust portfolios for now. The sector, nevertheless, had been one of markets’ favourites over the past months for playing the re-opening trade and rising inflation and interest yields. For sustainability reasons, however, we preferred to overweight the financial, and not the oil sector for the same reasons.

Mabrouk Chetouane, Head of Global Market Strategy, Solutions, International
Natixis Investment Managers

Mabrouk Chetouane

Even if we see some sort of “de-escalation” on the Russian-Ukrainian front, prices are likely to remain underpinned for some time.

Financial conditions tightening combined with higher inflation impact negatively households and companies’ income. Thus, although policymakers remain ultimately data-dependent, the risk for a yield curve is flattening tilted to the upside.

In this context, risky assets may suffer, and bonds may not offer their usual protection to portfolios. In order to protect portfolios from this adverse scenario, especially in the short term, we increase the inflation break-even exposure, underweight sovereign bonds and equities, while maintaining a value bias in portfolios.

Sébastien Page

Sébastien Page, Head of Global Multi-Asset and Chief Investment Officer
T. Rowe Price

While it is too early to talk of a recession, the possibility of an economic slowdown beyond what has been priced in seems to be increasing.

In our multi-asset portfolios, we prefer cyclically oriented equity markets such as global ex U.S. equities, value stocks, and small-cap names. We also favour emerging markets equity, which is benefiting from a pickup in demand and improving vaccine distribution.

Floating rate loans are attractive in a rising rate environment given their yield advantage and lower duration profile. China is loosening as the developed world is tightening. This could make China — and emerging markets more broadly — an interesting contrarian trade for 2022. 

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