Submitted by Jeffrey Snider – Alhambra Investment Partners
Not long ago, I wrote that it was somewhat odd that more attention wasn’t being paid to sovereign wealth funds. This was only somewhat surprising given that oil prices were still thought “transitory” and thus the mainstream clearly felt there wasn’t anything deeper to be assembled from that. However, now that it has finally dawned that oil isn’t likely to go anywhere, the repercussions are going to be delivered even if “the market” hasn’t been prepared for it by Janet Yellen’s narrative. And it is such a simple process to grasp; high oil revenue flows to sovereign funds that end up in the world’s asset markets.
The reverse is equally true, particularly for those countries where $30-40 oil will trigger a so-far indeterminate counterflow. That this reversal has started already, rather widespread too, is not a good sign. It is difficult if not impossible to gauge exactly how that might intertwine in already-sensitive markets, but the logic of it is quite easy to grasp.
Less oil revenues in a great deal of that $7 trillion plus gains heightened scrutiny about fund performance derived from stocks, and then may add up to knock out one of the largest supporting “pillars” that keeps global stock prices from joining the spreading reset in fixed income. As it is, even the Hong Kong fund reported losses YTD of HK$35.9 billion from forex alone, meaning that redeployment and redirection is likely systemic.
There appears to be something of critical mass forming, as the frequency of these kinds of announcements is just now starting to register. From the Wall Street Journal later last night:
Funds like Samruk are at a critical juncture. For years, sovereign-wealth funds—financial vehicles owned by governments—swelled in size and number, fueled by rising oil prices and leaders’ aspirations to increase economic growth, invest abroad and boost political influence. A new wave of sovereign funds came from African countries like Ghana and Angola. Asian nations joined in with funds like 1Malaysia Development Bhd., or 1MDB.
The world’s sovereign-wealth funds together have assets of $7.2 trillion, according to the Sovereign Wealth Fund Institute, which studies them. That is twice their size in 2007, and more than is managed by all the world’s hedge funds and private-equity funds combined, according to J.P. Morgan Asset Management.
Along with corporate repurchases, there is no doubt that these funds, predicated on oil revenue, have been an important source or pool for all kinds of asset markets (corporate repurchases get recycled into other markets beyond stocks in various ways). The problem with such growth and flow is correlation. Throw in general liquidity problems via the global “dollar” and the exits are incredibly narrow just in time for the reversal (as if it ever works out any other way). In other words, the more oil falls and looks to stay that way, the more likely that sovereign funds not just withdraw from assets but actually become even more price sensitive in doing so.
Selling is picking up. Sovereign-wealth funds yanked roughly $100 billion from asset managers in the six months to Sept. 30, according to Morgan Stanley. “The countries that have accumulated these vast reserves over the last 20 years will be dipping into those reserves,” Martin Gilbert, chief executive of $430 billion Aberdeen Asset Management, told reporters in November. “It could be a difficult 2016.”
In the parlance of orthodox economics, the nested behavior is highly pro-cyclical; selling begets only more selling, especially as liquidity (as illiquidity) makes it even more difficult to choose to exit at “decent” prices. What starts as a determined trend risks becoming a stampede because of that drastic shut off of oil revenue; risk taking and patience turns very quickly into preservation at all costs. Undoubtedly, there has been some of that already as it is quite reasonable to assume these funds have been “reaching for yield” in junk corporates as well as all manner of less visible “risk.”
This may well be an underappreciated element of 2015, the year oil stripped the positive asset flow and vibe; another factor the FOMC didn’t see coming. It is my suspicion, however, that in 2016 it may not be so underappreciated.