The drop in oil prices impacted many risky asset classes such as high yield debt, emerging market debt and commodity related equity sectors. With many pockets of the financial markets coming under stress, the selling pressure generalized in an environment of poor liquidity where many long positions built in anticipation of a year-end equity rally had to be cut.
Energy sector takes a nasty blow
We see the recent spike in risk aversion as temporary
Risk aversion increased sharply in December. The end of the year is usually a period of low liquidity in financial markets. This year, liquidity was even further reduced by investor concerns about the fall in oil prices, a looming financial crisis in Russia, the political situation in Greece and credit contagion fears. As a result, volatility spiked with investors selling risky assets for safe havens.
The announcement of earlier presidential election in Greece and a significantly increased probability of general elections over the next couple of months triggered the biggest one-day drop in Greek equities since 1987 and tensions on Eurozone peripheral sovereign bonds. The steep fall in oil prices added to the worries because it creates near-term friction in the energy sector, could lead to rising defaults in high yield space and might create (geopolitical) tensions for commodity exporters. Finally, the volatility of December market moves was also partially due to the adjustment in investor positioning, many of them having moved their risk-taking up in recent weeks in anticipation of a December rally.
We believe that on balance low oil price strengthens the medium term growth outlook for the global economy. We therefore see the December spike in risk aversion as temporary and consider it a buying opportunity for risky assets such as equities and listed real estate.