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The halving in oil prices is the biggest economic change we have seen since the 2008 financial crash. There are winners and losers everywhere from it, but there’s one standout winner: the European Union, which produces only 12% of the oil it consumes. As Americans we are probably underweight Europe, because for the last decade we are used to thinking of it as an over-bureaucratized, slow-growth mess. Well, that’s about to change and it’s time we added some Europe exposure to our portfolios.
Contrary to the views of most of the media, the U.S. doesn’t benefit much from lower oil prices. Yes, consumers get more money to spend, and that’s good. But the U.S. is nearly self-sufficient in oil, so for every $1 a consumer gets to spend, an oil company loses 80 cents. What’s more, there’s a capital effect. Much of the new U.S. oil production comes at high extraction costs from companies with relatively thin capitalization and lots of leverage. That means, if prices stay low, we’ll see a lot of bankruptcies in the oil patch. That investment, once lost, won’t be coming back, and will damage both the banking system and the bond markets.
There’s a timing effect here. The benefits from lower oil prices flow through to consumers almost immediately. That’s why recent U.S. economic numbers have been robust, and for the first time since 2009, people are happy about the economy. However the costs of lower oil prices are hidden in company balance sheets – reported several months after the fact. What’s more, most companies have reserves of cash and unused borrowing facilities, so bankruptcies won’t happen immediately. This pattern, of good news first and bad news later, is fooling people, and it appears to be fooling the stock market, still close to an all-time high.
Winners and Losers
Outside the U.S. there are some obvious winners and losers. Canada is a loser – its big oil reserves are high-cost tar sands, so its oil companies will suffer in a period of lower prices. In Latin America, Brazil will suffer more than Venezuela, because Venezuelan oil is mostly low-cost, while Brazil’s new oil is deep sea and high cost. Venezuela is in budget trouble because it spends the profits from oil extraction on social programs, but it just has to devalue the bolivar and can then continue doing so, as the fewer dollars coming in will buy more bolivars (in which most social programs are denominated.)
In Asia, China, India and Japan are big winners, because they all have little oil compared to their consumption, while Malaysia is a loser, the big losers being in the Middle East and the oil producing countries of Africa. China and Japan however both have their own problems; China has huge bad debts in the banking system while Japan’s government budgets and debt are way out of kilter.
And then there’s Europe. We’re used to thinking of Europe as a basket case, because the euro crisis from 2010 has caused it to be mired in recession longer than the U.S. And there’s no question some European countries, such as Greece and Italy, are a genuine mess – Italy for example has public debts almost twice the U.S. level (in relation to GDP) and hasn’t enjoyed any growth in GDP per capita this century – on World Bank data, its real GDP per capita is lower than in 1999.
However, northern Europe is very different. Both the World Bank and the Heritage Foundation rank several European countries above the United States in terms of economic freedom and ease of doing business. With the boost from cheaper oil, those countries’ anemic growth rates should improve sharply, and even the drag of the Euro currency should lessen. So it makes every sense for us as U.S. investors to have some European stocks, as follows:
iShares MSCI Sweden Fund (NYSE: EWD). Sweden has the advantage of not being in the euro, so can’t be forced to bail out the likes of Italy and Greece. Moreover, while its government is large it has many impressive companies and its integrity level is high. In October, the IMF expected Sweden’s 2015 growth to come in at 2.7%, but with the further decline in oil prices it ought to do better than that. EWD also has a nice yield of 3.9% and is selling on 16 times earnings.
Sky PLC (OTC: SKYAY) is the UK and Ireland’s satellite TV operation of News Corporation, a business which benefits greatly from consumer spending. It’s trading on 14.5 times prospective earnings, so is a cheap entry to a market that is still growing.
Novo Nordisk A/S (NYSE: NVO) is a pharmaceutical company based in Denmark but with worldwide operations. It’s trading on 22.6 times prospective 2015 earnings, which is a little pricey (it has a small dividend yield of 1.4%), but as a specialist in diabetes care it’s likely to see a growing market from aging both in Europe and worldwide.
You’re probably dependent on the U.S. for most of your income, from work and investments. This year, you need to diversify into Europe.
Saudi Arabia’s Plot Backfires!
When the Saudis announced they would not cut production to bolster oil prices, the intent was obvious. The move was meant to drive down crude prices, and punish the U.S. oil industry. The US had already over taken both Saudi Arabia and Russia in crude production – and the Arabs thought they could stop it with this move. WRONG! And we’ve found a great way for the average guy to cash in. Click here for all the details.