Ashburton's strategy note
In mid-March, we created a shopping list of developments that we felt would support an upgrade in our cautious optimism stance and an increase in our equity weightings. By early May, most of the boxes had been ticked and we duly upped our exposure. Since then, equities have struggled to make further upward progress as the one remaining unchecked box, namely the high oil price, has taken its toll on sentiment.
High food and energy inflation is arguably the biggest cloud hanging over the markets today. It is generating social tensions, sapping consumers spending power and is creating considerable uncertainty regarding the outlook for interest rates. It is particularly bad news for Asia, which imports a lot of oil and spends a significant proportion of its income on food. The response of politicians has been predictable but misconceived. If the world is short of commodities today it is largely as a result of government interference. The European Common Agricultural Policy has resulted in farmers dumping excess output on the world market thereby depressing prices and discouraging investment. Similarly, the nationalisation of oil companies has promoted inefficiency and under investment. And yet bizarrely, politicians seem to believe that the answer to the current commodity crisis is more interference rather than less.
Our base case has been that Asia would fight inflation with currency revaluations. With hindsight we should have qualified that position. Asia has proven itself unwilling to revalue its currencies (and thereby threaten the competitiveness of its export) at a time of global economic uncertainty. In the meantime, it has resorted to subsidies and price controls, policies which will do nothing to address the underlying problem (indeed they prevent the price mechanism from working) and are a huge drain on the public purse. Thankfully, there are already signs that the crisis may be close to its low point. Slowly but surely, Asian governments are seeing the error of their ways. What's more, many commodities are already turning over: wheat is already down over 40% and rice is down 25% despite the environmental disasters in Burma and China. The exponential rise in oil suggests that momentum investors have concentrated their buying power on the one major commodity that remains in an uptrend, but our guess is that trend will also blow itself, albeit at perhaps higher prices. The bottom line is that we see further downside for stocks in the near term, but a peak in the oil price should herald the next up-leg in share prices.
Peter Lucas, Global Investment Strategist. Ashburton (Jersey) Limited
