Jeff Young, fund manager NexGen Canadian Large Cap, NexGen North American Large Cap, NexGen Global Dividend, and the NexGen Canadian Diversified Income Fund.
Since my last commentary in January, the largest external driver of equity markets has really been the civil unrest that we're seeing in North Africa, and the Middle East. Now the initial problems in places like Tunisia and Egypt was largely ignored by commodity and equity markets as their impact on the global economy is relatively small.
Now the problems in Libya have been taken much more seriously, given Libya's role as an oil producer, an exporter of a million barrels a day. We've also seen some unrest in Bahrain, home of the US Navy's 5th fleet, and that's being watched quite closely. Bahrain's only a small oil producer, but its very close politically and geographically to Saudi Arabia, the world's largest oil power.
Now leaders in Saudi Arabia are offering to improve benefits for their population in order to head off mass unrest in that country, however, it remains to be seen whether those measures will be enough.
In Saudi Arabia, 60 percent of the population is under 18 years of age, and almost half live in poverty, so increased unrest is certainly possible.
Dissidents are using social media to organize a nationwide protest in Saudi Arabia on March 11, so it remains to be seen how big that will be. and well be watching that closely.
While all these events are very interesting and important from a humanitarian and a geo-political perspective, they're also very important from an investment perspective.
Despite years of talk and some progress towards a green economy, global economic activity still runs on oil and any threat to the consistent supply of oil raises the prices and acts a tax on both [general] production and consumption and threatens economic growth.
Now, elevated oil prices combined with the current and planned reductions in monetary and fiscal stimulus would create powerful headwinds for economic growth and consequently for equity prices.
The economies of large oil importers like the US, Japan, Germany and even China, would be especially affected.
Canada on the other hand has the advantage of being an oil producer and an exporting country which may help mitigate the impact of rising oil prices. That said, not all sectors of the economy will escape unscathed.
If higher oil prices were to meaningfully slowdown the economic growth, we'd expect to see weakness in the consumer sector, particularly in consumer discretionaries, or high priced items. Slowing economic activity, a less confident consumer, combined with increasing input costs are not an attractive combination and profit margins would undoubtedly suffer.
On the other hand, bonds and high yielding equities could be beneficiaries in this scenario as geo-political uncertainty, risk aversions grow, and economic activity slows, you would see bond yields go lower. High Yielding oil related equities with the ability to grow their production would certainly be very attractive in that sort of environment.
Now the final impact of the popular movements in the Middle East remain to be seen. Its possible that a relative quiet will once again return to the region without any long term impact on oil prices, but its far from certain and the situation bares close watching.
Now while stock returns are based on the fundamental attributes of each company, these fundamentals are heavily influenced by the economic environment. Input costs, customer demand and financing rates all impact individual companies and all are based on the broader economy.
Now if we want to understand how a company is going to perform in the future we need to try to understand the external forces that it faces. For now, we believe the global economy will continue to grow and the environment remains positive for equities. That said, many potential headwinds exist, making prudent portfolio management critical.
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