US president Donald Trump has a negotiation style that has added further complexity to an already complex investing environment.
Certainly black box investors continue to use the presidential tweets to make short-term trading decisions, but human investors quickly realised they were better served by being more selective.
The US president’s brash communication style can also muddy fundamental stories.
Despite significant rhetoric, the US-Chinese tariffs imposed so far pale in comparison to those scheduled to take place.
Questions over the prudence of stimulus in a presumptive late-cycle economy also hide the basic need for a military budget that maintains current equipment.
The positive effects from a capital expenditure tax credit are one of the most under-reported features of the US tax code changes, despite their ability to increase productivity and offset negative effects of wage gains.
Much needed entitlement reform is better enacted in a 4 per cent economy than the 2 per cent version that gave birth to populism.
But the war of words between President Trump and the president of Iran, Hassan Rouhani, was slightly more guttural in nature, seeming to strike at the heart of long-standing disputes in the region. For that reason and more, the oil market took these threats more seriously.
The imposition of Iranian sanctions in November and their potential to raise oil prices higher than the economy can support, reminds us of oil driven economic slowdowns of the past.
We do not think this marks the beginning of another stage in oil’s rise that has seen prices increase by over 60 per cent in the past 12 months.
Figure 1: Oil prices have been on the increase in the past 12 months
Source: Datastream (as of 30 June 2018)
To begin with, we believe there is a 70 per cent chance the sanctions will not take effect in November.
The two people with the most to lose from the removal of 2.5m barrels per day (bpd) of Iranian exports from the market are the US and Iranian presidents. They are also the people best placed to control or change that outcome.
However, in the 30 per cent chance that the sanctions do take effect, there are methods available to Iran for exports to continue and, in the worst case scenario, we would expect a drop of only 500,000 bpd, especially as China is unlikely to fall in line.
Furthermore, demand is unlikely to hold up to oil at any price, given the increase of the past year has already produced signs of stress. Indian officials have warned Opec counterparts that Brent at $80 (£61) will erode energy demand and jeopardise the country’s expansion.
Elsewhere, higher fuel prices have led to protests and strikes in Brazil, Haiti, Guinea and Serbia, while traffic volumes in the US have declined year-on-year for the first time since February 2014.
Nor is supply supportive of a price increase either. Opec and non-Opec producers have agreed to increase production to account for any shortfall in production below the allowed target.
Both Saudi Arabia and Russia increased production before Opec’s official meeting in June. In the US, meanwhile, crude production increased by 1.1m bpd in June, a rate that has resulted in pipelines reaching capacity limits.
Overall, we believe external forces have driven the oil price above that justified by economic activity.
For now, we see a $60 (£45.8) to $70 (£53.3) range for the foreseeable future, a level that provides the profits necessary to ensure the allocation of capital to exploration and production but that does not threaten demand.
The recent pricing environment has been positive for the oil majors, with strong earnings and free cash flow reported in the first quarter of 2018.
With the additional cash generated from higher-than-expected prices, these large players can now cover their dividends, raising hopes of increased returns to shareholders.
Robert Minter is investment strategist at Aberdeen Standard Investments
