Is the re-pricing in stocks and oil complete?

May 28, 2010

Jane Foley is research director at The opinions expressed are her own.-

The better tone in stock indices and oil prices that has appeared this week begs the question as to whether the bout of re-pricing is complete.

The correction lower was arguably necessary to allow for the fact that the fiscal repair process which has started in parts of the Eurozone and will soon spread to the UK and then to the US next year will cap growth prospects for the industrialised world.

The likelihood that most countries in the industrialised world will see growth in the region of 1 percent and 3 percent this year did not sit comfortably with the exuberance of the recent rallies in assets such as oil and stocks.

The rally in the WTI oil contract took it from $33.98 /b in February last year to a high of $86.84 /b in April 2010.  While a re-pricing was probably unavoidable, it must be said that the economic news, particularly in the US, is not too bad.  Recent US economic data has been sufficiently robust to allow some forecasters to draw the conclusion that the US recovery is now self-sustaining.

The Federal Reserve recently increased its growth forecast for this year to 3.45 percent.  Stronger growth should undermine fears of contagion from the Eurozone debt crisis and will likely allow for a relaxation in some of the market’s indicators of risk and bring further bargain hunters into stock markets and into oil.

This may bring a little support into the near-term outlook for commodities.  That said the reprieve from bad news on the European debt crisis may be short-lived.  On top of that, it is likely that a strong USD will continue to weigh on the prices of dollar denominated commodities.

The relatively better US economic outlook will likely help strengthen the dollar’s relative position in the second half of this year particularly given the fact that in Europe there is still the risk that further bad news will emerge.

Fears that the European banking sector is sitting on bad debts will likely be sufficient for the market to remain nervous and for the euro to remain under pressure medium-term.

The recent failure of the small Spanish savings bank Cajasur has drawn attention to the fact that the Spanish property crash may yet bring bigger causalities.  News from the Spanish regulator that it has tightened its rules for banks’ provisions against bad loans will help shore up confidence in Spain’s banking sector over the longer-term.

However, in the near term is may bring forward the shake out of the banks most heavily exposed to the Spain’s crumbling property market; suggesting more bad news is possible over the next couple of months.

On top of the risk that Greek debt may yet have to be re-structured, this is of particular concern.  Outstanding Greek debt is in the order of USD350 bln; to put this in perspective, the Russian debt default in 1998 was in the region of USD73 bln.

Pending economic data will help determine whether the stock market has seen a bottom or just a temporary base but with safe haven flows potentially further emphasising the strength of the USD, the near-term recovery in oil may prove shallow.  Potential remains for oil to fall back to $60 /b in the mths ahead.

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