Who or what is triggering the sell-off in the markets? The first weeks of 2016 have been turbulent at best. Nobody can take the blame exclusively. Yet there are distinct market forces that have been liquidating large positions. Among those responsible, the oil-producing countries’ sovereign wealth funds (SWFs) may be the ones to blame for the stock market crash in 2016.
Rothschild & Sons Deputy Chairman Paolo Scaroni told Bloomberg, “They [SWFs] are selling, they are selling a lot… This is a key reason I believe that the stocks of the big financial institutions have been hit so hard in the market selloff.” (Source: “Sovereign Wealth Funds Draining Market Liquidity,” Trefis, February 10, 2016.)
Those looking in the SWFs’ direction to explain the market sell-off have evidence to support their suspicion. Oil prices are low. RBS analysts observed that the sale of crude converted to some $700 billion and $800 billion to oil producers’ coffers when prices were high. This offered plenty of surplus for governments to reinvest in the markets. Now, this cash flow has been more than halved.
Three Reasons to Be Worried
- The big idea of SWFs is to transfer some of the wealth generated by a finite resource, such as oil. The wealth is then stored (invested) and shared with future generations. As of October 2015, Norway, an oil producer, had some $900 billion in SWFs. Abu Dhabi had more than $700 billion, while Saudi Arabia and Kuwait had more than $500 billion each. (Source: “Sovereign wealth funds are flogging assets – and that means big trouble,” MoneyWeek, October 17, 2015.)
While oil prices have collapsed, governments have been forced to draw from SWFs to avoid a stock market crash in 2016. The resources to fill SWFs, in turn, are missing. Meanwhile, equity and bond markets have coped with less liquidity than in previous years. The dramatic collapse in oil prices (some 75% lower over the past two years) has drained the resources of all producers. It has even caused an $87.0-billion budget deficit in Saudi Arabia.
- This is significant. The Kingdom has rarely experienced a deficit. More often than not, it has a surplus. To cover the unprecedented budget shortfall, the Saudis will have to use debt. The Kingdom has issued a U.S. dollar-denominated bond to this effect—the first since 2007. The Kingdom has even decided to float Saudi Aramco, the world’s largest oil company, in the markets. Of course, it is also disposing of assets. In 2015, Saudi reserves of foreign currency fell by about $73.0 billion. The SAMA (Saudi Arabian Monetary Authority) Foreign Holdings Fund decided how much and where these assets should go. (Source: Ibid.)
- This is how the SWF sell-off works. When a hypothetical SWF that has invested $100 million is forced to sell 10% of that investment, the market will note an outflow of $10.0 million. This might affect some smaller stocks. Nevertheless, it would hardly influence the market in general. However, with the oil state’s SWF, which by some estimates controls some $7.3 trillion altogether, the effects are magnified. Selling off even five percent of this vast portfolio can produce hundreds of billions in outflows. These can certainly influence the market’s performance. In addition, it is perhaps the main reason why low oil prices, once midwives to economic growth, are pushing toward recession.
Sovereign Wealth Funds a Hot Topic
A quick way to describe SWFs is government-controlled funds invested in international securities against which that same government has no liability. This aspect clause segregates them from other government-controlled investment entities, such as public pension funds.
Many consider SWFs to be “big players.” Perhaps “market disrupters” might be a better term, despite the fact that the financial press rarely warns investors that these are the very forces that can bury them in a stock market crash in 2016. (Source: “Beware of the market disrupting ‘Big Players’,” Gulf News, February 11, 2016.)
SWFs have the power to disrupt or stabilize markets. They appear to enjoy their disruption talents more.
In the now nostalgic days when crude prices were high and grass was green, oil-producing countries, many of which are in the Middle East, accrued significant amounts of foreign reserve surpluses. This encouraged SWFs to scale their risk appetite over the past few years. During the financial crisis of 2008, SWFs earned a reputation as forces of financial stability. They even saved the troubled banks. (Source: “Financial Crisis, SWF Investing, and Implications for Financial Stability,” Global Policy, April 2, 2012.)
Yet, multilateral institutions, such as the OECD or the IMF, as well as investors in general, have grown weary of the lack of transparency with SWFs. These funds risk operating based on political motives, for example. The IMF was drafting a code of conduct for SWFs (generally accepted principles and practices) in 2008, but concerns remain.
Beware of the market-disrupting big players, benefiting from having independent governance structures and behavior.
The major SWFs could operate from a position of strength in the aftermath of the 2008 sub-prime crash thanks to their immense financial resources. Today, the picture has radically changed. This is because the main source of their wealth—oil—has been greatly devalued.
Still, the market’s recent behavior betrays SWFs’ autograph.