Street explained: Mystery force moves market

Published Tue, Feb 2 20166:00 AM ESTUpdated Wed, Feb 3 20167:18 AM EST

Traders have been speculating for several weeks that a part of the global selling in stocks that started in December may be due to oil-related sovereign wealth funds selling assets in order to make up for the shortfall in revenues due to the decline in oil. We are starting to get some data that indicates that at least part of the selling may indeed be due to this type of selling, particularly regarding the weakness we have seen in financials. Oil-related SWFs have significant assets. The Sovereign Wealth Fund Institute estimates that the assets under management of the largest oil-producing SWFs (Norway, Abu Dhabi, United Arab Emirates, Saudi Arabia, Kuwait and Qatar) amounts to $3.2 trillion. On Friday, JPMorgan released a report on global flows which concluded that oil-producing countries were indeed net sellers of assets last year. Government bonds $90B Equities $50B Corporate bonds $7B Cash $15B Total $162B Source: JPMorgan This is a large — but not huge — part of their available assets. It would represent roughly 5 percent of their $3.2 trillion in assets, still a sizeable sum. However, if you remove the largest SWF — Norway, at $825 billion in assets, and include only Middle East SWFs, it would represent roughly 7 percent of assets. That's sizeable. What's interesting is that the holdings are not evenly distributed. For equities, SWFs have the largest percentage of their assets in Western Europe (roughly 55 percent), followed by the Middle East and Africa (approximately 28 percent), Asia-Pacific (developed)(roughly 12 percent), and Asia-Pacific (emerging — roughly 8 percent). Only about 4 percent of the equity assets are in North America. In terms of sectors, SWFs are most overweight financials and consumer discretionary . This parallels a similar conclusion by research firm Strategas, which in a recent report to its clients concluded that financials were far and away the most at risk from SWF selling. Financials 45.9 percent Consumer Durables 16.3 percent Utilities 8.3 percent Communications 4.2 percent Technology 3.7 percent Energy/minerals 3.5 percent Other 15 percent Source: Strategas Bottom line: If SWFs were selling equities, banks — particularly European banks — would be a good place to look. This makes some sense, as it fits the facts we have. We know that: European equities are the largest holdings of oil-related SWFs, and financials are the largest equity sector holding. European banks notably underperformed the markets in December and January, the months with the heaviest selling. For example, in December a big European banks like BNP Paribas was down 7 percent, Deutsche Bank down 7 percent, Banco Santander down 12 percent, while the STOXX Europe 600, a broad measure of the overall European market, was down 5 percent. In January, BNP Paribas was down 16 percent, Deutsche Bank down 27 percent, Banco Santander down 14 percent, while the STOXX Europe 600 was down only 6 percent. In other words, someone was selling European banks like crazy in December and January. What about 2016? Assuming an average oil price of $35, JPMorgan estimates that the current account deficit will worsen, resulting in even more selling from oil-related SWFs: Government bonds $107B Equities $80B Corporate bonds $12B Cash $19B Total $218B Source: JPMorgan By the way, just because SWFs have relatively small holdings in the U.S. doesn't mean there are not knock-on effects from heavy selling in Europe. Holders of U.S. bank stocks were certainly spooked by the large declines of their European counterparts in December and January, and they certainly sold in sympathy. Whether the holders were hedge funds, pension funds, or Middle Eastern sovereign wealth funds didn't matter.

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We are starting to get some data that indicates that at least part of the selling may indeed be due to this type of selling, particularly regarding the weakness we have seen in financials.

Oil-related SWFs have significant assets. The Sovereign Wealth Fund Institute estimates that the assets under management of the largest oil-producing SWFs (Norway, Abu Dhabi, United Arab Emirates, Saudi Arabia, Kuwait and Qatar) amounts to $3.2 trillion.

On Friday, JPMorgan released a report on global flows which concluded that oil-producing countries were indeed net sellers of assets last year.