Is the oil fall a black swan event?

Nassim Taleb describes a black swan as : A BLAC K SWA N is a highly improbable event with three principal characteristics: It is unpredictable; it carries a massive impact; and, after the fact, we concoct an explanation that makes it appear less random, and more predictable, than it was.

Lets look at Oil and check whether it fits the definition.

Was the steep fall in oil something that was predicted: No. I know of no study that suggested oil prices will fall and fall so steeply.

Is it something that shall have a massive impact elsewhere: Yes, oil is the main currency of many countries. While many are small, we do have a entire sub-continent in Middle East which depend on oil for most of their revenues. We also have Russia which has huge dependency on Oil to balance its budget.

While there is a direct benefit to countries such as India since we pay a lower price for oil, we will get impacted too as a large part of our foreign exchange earnings comes from Indians working in Middle East and repatriating a major part of their earnings. If that is impacted, it will have an impact on the Rupee – USD which in itself will then impact on a whole lot of other industries.

And finally, are we able to con-cot a explanation for the fall: Yep, blame the shale oil for the fall say the experts. Yes, a surge in production in US may indeed have had an impact, but why was that impact not a slower process than one we have seen.

Well before oil fell, Coal prices were falling at a pretty steep pace. But interestingly that was not seen as damaging (other than for countries such as Australia / Brazil among others). The question though is, was it a fore-bearer to the crisis that is coming?

Collateral damage is pretty hard to predict. Russia is going through a crisis that seems to show no signs of ending. In 1997, they defaulted on their own currency bonds and hell broke out in most markets though India being more closed was relatively safer. But if we were to see a repeat of something on that scale, what would be the probable impact?

Much of the rise in markets has been due to the continuous flow of funds by FII’s. How much of the funds are coming from countries (sovereign funds) or funds that have exposure to oil (directly or indirectly). Last week saw them selling though the net impact was +ve due to the sale of shares by Infosys promoters. If one removes that trade, net flow is -ve. If oil is really a positive to India, why are FII’s starting to pull out now?

One of the key reasons for the sudden crash in ASEAN countries was the over-leverage by corporates and countries since the currency rate being fixed, the assumption was that it was a zero risk venture. How many of our big caps have un-heged overseas exposure that may come back to haunt them in case Rupee takes a tumble?

Of course, all is not lost as of now. Nifty trailing four quarters PE is not exactly in bubble territory. But that said, we aren’t cheap and unless we grow, even these levels aren’t sustainable.

The last time we fell from a similar PE level was in 2004 and while we did recover, the Draw-down in that year was 30% from the peak. At current Nifty, that would mean a fall to 6000, something that was seen way before the “Acche din affect”.

In one of my earlier posts, I had provided the future returns based on current Nifty PE and at 21.5 (where we were a few days ago), we were coming close to a point where we had a average gain of a few percentage points over the next three years.

I don’t believe that the way forward is by trying to predict, especially using macro views. After all, the housing bubble that was the reason for 2008 began not in 2007 but in 2005 and by 2006, it was seen as spreading like a wild weed. Markets take their own sweet time to react to events and it makes zero sense to try and trade on that. Instead, what we need is a plan, a plan on what will one do if our portfolio drops X% and what they shall do when it drops X-10%.

Every crisis is a opportunity if only you can survive the crisis in the first place. Opportunities come once in a while and only early preparation can help one not only to tide over the crisis but take advantage of the same. So, write down your plan and more importantly, stick to it.

Advertisements

About Prashanth

Have been a full time participant in the stock markets since 1996. Run a Yahoo Group where focus is exclusively on discussions of the Indian Markets using Technical Analysis as the tool (groups.yahoo.com/group/technical-investor)
This entry was posted in Uncategorized. Bookmark the permalink.

3 Responses to Is the oil fall a black swan event?

  1. Jigs says:

    Don’t think its a black swan event. At the most Nifty could touch 200 DMA (7489) IF we were to see repeat of Russian default or LTCM – (like 1998) .
    After fall of crude IMF has raised US gdp growth from 3.1% to 3.5%. US consumers could save total of $175 billion over next year. So, Any slowdown in Inflow from oil exporting nations could get offset by similar inflow from US.
    Rupee can depreciate and that may continue till DXY goes up but that is positive according to me as long as it depreciates slowly and steadily.
    However, I was wrong before May 2014 so could be wrong again :).

  2. BJ says:

    Have not points to disagree with the article, but adding some of my thoughts here.

    I think the reason Oil fell as sharply as it did is that

    1) The fissures in the OPEC cartel itself is coming to fore. 10 years down the line, with energy substitutes in place will the OPEC even exist?

    2) There was lot of hope that Chinese and Indian consumers will consume oil more and more. But simple demand economics states that with higher prices the demand goes down even if it is a critical everyday item like oil products. This hope of rise in consumption is now shattered.

    3) The predatory pricing theory is kinda way off because now, past Peak-oil the OPEC and other countries would want to use their resources to get max. I mean, I really dont get the logic of why Saudis would want to give oil at 50% discount just because there is a new shop in town. All US gov has to do is to extend its Shale oil industry a series of tax cuts or bond rebates, and they will be back. They (Gov) bought trillions in toxic assets with no hope of getting its money back, the Shale oil bonds are much more worthy investments. Would Saudi not have discounted this support to Shale?

    4) Russian theory is still better. But all Russia has to do is to wait out the depression and look east. South Sea pipeline cancellation is the first move in that direction. Probably they dont think Europe needs the kind of infra expenditure to sell it any of its gas. China and India should be more than enough. We should hear something on this front very soon.

    5) Positioning wise – it was just crazy. The last COT report is still crazy. Hedgies were buying in at high levels. Stronger hands – Saudis and all, if they were short or hedged would still recover substantial amounts of “losses” of selling at sub-70s. But that is not the complete market.

    We cant dream of free energy but it is likely to be a medium term technical dip than anything else. Once the growth engine starts, oil will be needed again.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s