Weak Chinese and Saudi Arabia oil attack end equity rally

Equities 5 minutes to read

Peter Garnry

Head of Equity Strategy

Summary:  Last week was risk-on as equities were discounting improved macro data on the margin and ECB stimulus. But the risk-on sentiment is on the back foot this morning as the market got its biggest oil price shock since the early 1990s as Saudi Arabia's largest oil processing facility was attacked by drones over the weekend. In addition, China released worse than expected industrial production and retail sales figures for August highlighting the fragile economy that has taken a hit from the US-China trade war escalation.


Last week we highlighted that macro surprises had turned positive among G10 countries. This fact combined with rising expectations for ECB stimulus, which did not disappoint according to price action, were likely the cause of why we saw an extension of the equity rally. But the weekend’s attack on Saudi Arabia’s largest oil processing facility and today’s weaker than expected Chinese macro data have for now ended the equity rally.

Recession probability has increased

The current US recession probability within the next 6-12 months is around 25-35% based on macro data available as of August. The weekend’s attack in Saudi Arabia has the potential to lift oil prices a notch on rising security and geopolitical risk premium which is obviously bad as it comes during an economic slowdown. Short-term energy stocks are bid, and investors are selling carmakers, airliners and industrials as higher energy prices mean higher input costs. Despite the short-term jump in oil stocks we remain negative and underweight energy stocks.

iShares STOXX Europe 600 Oil & Gas ETF

Source: Saxo Bank
On top of the oil price shock China released worse than expected macro numbers in August across industrial production and retail sales. China’s 3-month average industrial production y/y is the weakest since early 1991 and highlights that the slowdown continues despite stimulus already deployed by the Chinese government. It indicates how severe an impact the trade war is having on the Chinese economy and we expect that the Chinese government will initiate renewed stimulus soon.
Source: Bloomberg

Stocks to watch

The drone attack on the world’s largest oil processing facility and the jump in oil price have naturally caused oil companies to jump in Asian session. CNOOC shares are up 6% on the back of higher oil prices. However, the question is whether the jump in oil stocks makes much sense in a bigger context. A temporary oil supply shock should not proportionally move oil stocks as most of the oil company’s value lies in the terminal cash flows which are determined by long-term dynamics. In addition, Saudi Arabia had been lowering its production for more than a year, so the country has excess capacity to close the gap.

Source: Saxo Bank

But if this weekend’s attack means a permanent security risk premium on energy infrastructure then gains in oil stocks should not be faded and are justifiable. On top of a security risk premium the attack means that a geopolitical risk premium is likely being built into oil prices which again is a net positive for oil stocks. Pulling the other way is the fact that a higher oil price from a supply shock in a weakening economy

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-hk/legal/disclaimer/saxo-disclaimer)

Saxo Capital Markets HK Limited
Rooms 2001-02, 20/F York House
The Landmark
15 Queen's Road Central
Hong Kong

Hong Kong S.A.R

Saxo Capital Markets HK is a company authorised and regulated by the Securities and Futures Commission of Hong Kong. Saxo Capital Markets HK Limited holds a Type 1 Regulated Activity (Dealing in securities); Type 2 Regulated Activity (Dealing in Futures Contract) and Type 3 Regulated Activity (Leveraged foreign exchange trading) licenses (CE No. AVD061). Registered address: Rooms 2001-02, 20/F York House, The Landmark, 15 Queen's Road Central, Hong Kong

By clicking on certain links on this site, you are aware and agree to leave the website of Saxo Capital Markets, proceed on to the linked site managed by Saxo Group and where you will be subject to the terms of that linked site.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

Please note that the information on this site and any product and services we offer are not targeted at investors residing in the United States and Japan, and are not intended for distribution to, or use by any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation. Please click here to view our full disclaimer.