The oil-rich sovereign wealth funds have it good, if we didn’t already know that. Citigroup’s Robert Buckland reinforces the idea in his latest Global Equity Strategy note to clients, in which he claims a new carry trade - with SWFs poised to be prime beneficiaries:
Just as the equity market looked cheap to anybody who could source capital from the debt markets between 2003 and 2007, now it looks cheap to anybody who can source capital from the oil market. And just as markets missed the point about private equity - they could afford to pay higher prices for assets given their access to cheap debt capital - maybe they are now missing the point about oil-rich investors. Most financial assets looks cheap when your source of capital is oil at over $100 a barrel.
The re-rating of global equities against oil over the past year has been just as significant as the re-rating of debt against equity that kicked off the de-equitisation trade. A combination of rising oil and falling share prices means that a barrel of oil will now buy enough equities to deliver $8 of corporate earnings per year (we divide the oil price by the market PE to calculate this), way up from the $5 that it would have bought a year ago.
Oil would need to fall below $20 a barrel to reduce that to its long-term average of $1.17 of corporate earnings, according to Buckland. While global earnings would need to decline over 80 per cent:
So great is the power of high-priced crude, the world’s oil reserves ($135tn) could buy the S&P 500 Index 11 times over, Buckland points out. Oil producers are being offered a “once-in-a-lifetime opportunity” to build up weightings in global equities at a time when nobody else wants to buy. Buckland suggests energy-sector shares would be a good hedge for the trade (a barrel of oil buying about $9 of annual earnings).
Other liquidity pools include FX reserves of non-oil exporters (Asian central banks), private equity (a 14 per cent increase in capital in the first-half of 2008), and government bonds:
Still, SWFs have tended to be rather cautious equity-investors, traditionally focusing on fixed income. Volatility and uncertainty in the equity markets may put them off further. Some SWFs have of course, already had their fingers burnt before investing in financials.
Related links:
Managers eye SWFs’ massive fortunes - FT
Lehman’s secret talks to sell 50% stake stall - FT
