Oil's plunge ensures more stimulus will be on offer

With the oil plunge driving down inflation in the developed world, central banks will be in no rush to turn off the stimulus tap.

One thing economists agree on this year is that developed-world inflation will be driven down by the plunge in oil prices, increasing the pressure on central banks to maintain or increase stimulus.

Even with the 60 per cent fall in oil prices in the past six months, consensus estimates for economic growth are yet to bottom. The World Bank expects only a 0.1 per cent boost to the global economy from lower oil prices this year, with the full effect likely to be several years away.

Lower oil prices might fuel stronger spending if global inflation were a bit ‘healthier’. But with Europe still grappling with the aftermath of the financial crisis, consumers may view the oil price fall as temporary, deferring spending decisions, and risking a disinflationary spiral.

The latest US economic data weren’t promising -- December retail sales undershot expectations because of lower petrol prices, suggesting consumers weren’t rushing to spend more.

Whether the economic growth impulse from lower commodity prices, central bank stimulus and US economic recovery offsets the deteriorating economic momentum in Asia and Europe is a major uncertainty for investors, and has been reflected in a 10 per cent fall in copper prices this week.

“Disinflation verging on deflation will be the key global macro theme for 2015,” according to Credit Suisse strategists Hasan Tevfik and Damien Boey.

“We expect asset prices to appreciate as central banks respond to the deflation threat.”

In their view, a combination of RBA rate cuts, a low cost of debt, solid free cashflow growth and a high dividend yield should overwhelm a weak macroeconomic backdrop and drive Australia’s benchmark S&P/ASX 200 up to 6000 by year end.

Index-weight investors are looking at a healthy total return of about 15 per cent if they’re right.

But their top picks in the Australian market this year will be those with potential to stand up to a sluggish economic environment by divesting assets, cutting costs and reducing capital expenditure.

On that basis, their favoured large companies include BHP Billiton, Rio Tinto, National Australia Bank, Woolworths, QBE Insurance, Lend Lease, Asciano and Toll Holdings.

At the smaller end, they like Investa Office Fund, Fairfax Media, Premier Investments, Super Retail Group, Asaleo Care, APN News & Media and OrotonGroup.

All of these companies trade on a price-to-earnings ratio discount of at least 15 per cent versus the market, with dividend yields at least 40 basis points better, the strategists say.

In their view, lower bond yields could go hand in hand with higher equities valuations.

That’s reassuring, since US 10-year Treasury bond yields hit a 20-month low of 1.78 per cent this week, and Australian 10-year Commonwealth Government bonds hit a record low of 2.57 per cent.

But just to highlight the degree of uncertainty this year, the strategists also have a couple of worrisome caveats to their bullish world equity market view.

If policymakers don’t deliver sufficient stimulus to head off deflationary pressures “we could see credit stresses re-emerge, causing the yield, or stimulus trade to break down,” they say.

Another risk is that aggressive Fed tightening ends up being premature.

“In this scenario, increases in the policy rate could put pressure on short-dated credit instruments as the search for yield unwinds. Credit would not be as freely available to support asset prices, business capex or hiring. Growth could be disappointing.”

Mercifully, the Fed has not locked itself into policy normalisation path this year.