JPM Explains How Crude Carnage Creates $75 Billion SWF "Contagion" For Equities

Tyler Durden's picture

Back in August, we explained why the great petrodollar unwind could be $2.5 trillion larger than anyone thinks.

China’s effort to “control” the glidepath for the yuan devaluation led to a dramatic decline of Beijing’s FX reserves and pushed reserve liquidation to the front of the market’s collective consciousness.

But “the great accumulation” (as Deutsche Bank calls it) of USTs ended long before the RMB deval forced the market to start talking about FX reserves. In short, the inexorable decline in crude prices (and commodities in general) forced producers to sell USD assets in an effort to offset pressure on their currencies and plug yawning budget gaps.

And while the world is now fully awake to the fact that these asset sales amount to QE in reverse (global central banks are selling the same assets the Fed once bought), what isn’t as well understood is that looking strictly at official FX reserves paints an incomplete picture. “Crucially, for oil exporting nations, central bank official reserves likely underestimate the full scale of the reversal of oil exporters’ ‘petrodollar’ accumulation,” Credit Suisse wrote last year. “This is because a substantial part of their oil proceeds has previously been placed in sovereign wealth funds (SWFs), which are not reported as FX reserves (with the notable exception of Russia, where they are counted as FX reserves).”

The difference between total SWF assets and official reserves for oil exporting nations is vast. "Currently, oil exporting countries hold about $1.7trn of official reserves but as much as $4.3trn in SWF assets," Credit Suisse went on to point out, adding that. "In the 2009-2014 period, oil exporters accumulated about $0.5trn in official reserves but as much as $1.8trn of SWF assets." Or, visually:

As you can see from the above, oil exporters' accumulation of SWF assets comes to a dramatic halt when crude prices fall. Critically, it's exceedingly possible that the accumulation of SWF assets turns negative now that the return of Iranian supply means oil prices are set to stay lower for longer. Or, as Credit Suisse put it, "now that the tide has turned, it is likely that not only official reserves drop but that SWF asset accumulation slows to nil or even reverses."

Perhaps the best example of this is Norway's SWF which, at $830 billion, is the largest in the world. 

Falling crude has put enormous pressure on Norway's economy, and with oil revenue plunging along with prices, the country is now set to drawdown its SWF rainy day fund for the first time in history in order to plug budget holes and pay for fiscal stimulus designed to offset some of the jobs lost to the industry downturn. The fund will still grow as long as return assumptions hold up, but as we saw in the first two weeks of this year, any "assumptions" about returns are dubious in an increasingly uncertain environment. Here, for reference, it a handy table lists SWFs by country and AUM:

It's important to understand that SWFs hold more than just bonds. That means that if SWFs become sellers, there are implications for other asset classes. 

Like stocks. 

Here are some findings on SWF equity investments from "Sovereign Wealth Fund Investments: From Firm-level Preferences to Natural Endowments," by Paris School of Economics' Rolando Avendano:

There is significant variance in the allocation of SWF equity investments, depending on underlying factors associated with the fund (source of proceeds, OECD “effect”, home/foreign bias). Whereas most SWFs are attracted to large firms, with proven profitability and international activities, differences among groups remain:

  • Non-commodity funds favour firms with more foreign activity and higher turnover, in contrast to commodity-funds.

  • OECD-based funds prefer firms with lower leverage levels, whereas non-OECD funds have a preference for profitable and international firms.

  • SWF foreign investments are oriented towards large and highly leveraged firms, in contrast with their domestic (small and low leveraged) investments. Foreign investments are attracted to R&D sectors.

  • In line with the previous literature, I find that SWF ownership has a positive effect on firm value. However, this effect is only significant for commodity and OECD-based funds.

The study was from 2006-2009 and one imagines some of these preferences might have changed in the post-crisis world, but the paper (found here) is still worth a read.

All of the above begs the following question: will the SWFs of oil producing countries be net sellers of stocks if crude prices remain subdued and if so, how much will they sell?

JP Morgan's Nikolaos Panigirtzoglou and team have ventured a guess. "In our mind financial contagion from lower oil prices to equity markets is created via sovereign wealth funds," JPM begins. Here's more:

The lower the oil price the higher the potential depletion of SWF assets as oil producing countries struggle to prevent their spending from declining too much. And the equities owned by oil producing countries SWFs encompass all regions and all sectors.


To assess SWF flows and their potential impact on equity market flows, we update our analysis on FX reserves and Sovereign Wealth Fund (SWF) assets for 2016 in light of the recent steep decline in oil prices. Using our average Brent oil forecast of $31 for 2016, how would oil-related financial flows look like in 2016?


In 2015, oil exporters (Middle East, Norway, Russia, Africa and Latam countries) received $740tr from their oil exports and will see their oil revenue decline further to $440bn should Brent oil price average at $31 this year. Oil exporters’ revenues are recycled via two channels: via imports of goods and services from the rest of the world and via accumulation of financial assets, mostly through SWFs. In 2015, oil exporters consumed $70bn more than their oil revenues to prevent their spending from declining too much. On our estimates, this excessive spending was met via around $50bn of FX reserve depletion and $20bn of SWF depletion.


Assuming a $22 decline in the average oil price in 2016 relative to 2015 (i.e. from $53 to $31), the oil exporters’ aggregate current account balance will likely decline to around -$260bn vs. -$70bn in 2015 (based on last year’s sensitivities of current account balance change to oil price change). This year’s dis-saving of $260bn should be mostly met via depletion of official assets, i.e. FX reserve and SWF assets ($240bn) rather than issuance of government debt ($20bn). For 2016 we look for FX reserve depletion of $100bn and a decline in SWF assets of $140bn.


Assuming selling in accordance to the average allocation of FX Reserve Managers and SWF across asset classes, we estimate that the sales of bonds by oil producing countries will increase from -$45bn in 2015 to -$110bn in 2016 and that the sales of public equities will increase from -$10bn in 2015 to -$75bn in 2016. There is little offset to this -$75bn of equity sales from accumulation of SWF assets by oil consuming countries, as we expect these countries to spend most of this year’s oil income windfall.  

In short, SWF's will liquidate some $75 billion in equities this year assuming oil at $31 per barrel. Needless to say, the lower oil goes, the more selling they'll be. 

"This prospective $75bn of equity selling by SWFs in 2016 is not huge but becomes significant after taking into account the potential swing in equity fund flows," JPM continues, in an attempt to discuss the impact this will have on markets. "Last year retail investors bought $375bn of equity funds globally. This year we expect an amount between 0 and $200bn. Subtracting $75bn of selling from SWFs would leave the overall equity flow from Retail+SWF investors barely positive for 2016."

Well, not really. It's "barely positive" if retail buys $76 billion or more. But if retail investors buy anywhere from zero to $74 billion, SWF + retail goes negative.

Needless to say, the first two weeks of the year haven't done anything to either shore up the SWFs of oil producers or put retail in a bullish mood. That being the case, the market better home the "smart" money is buying or you can forget about equities catching a bid this year.

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An infographic look

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Mr.Sono's picture

Oil to under 20
Oil to under 10

Captain Debtcrash's picture
Captain Debtcrash (not verified) Mr.Sono Jan 17, 2016 1:57 PM

The oil industry is looking more and more like a good candidate for a critical mass default.

Mr.Sono's picture

The fed planning to take care of that.

I am still trying to finger out, how collapse in oil will bring economy to stand still? I thought bonds were next to collapse. But they are safe haven for the masses at the moment. I don't see the big picture here. Maybe some one can explain.

bamawatson's picture

well speaking of 'finger' ing out; i can't finger out this article. must be peddling fear porn, my broker told me friday every thing is fine. in fact, it is so good that he does not even need to return my phone calls.

Mr.Sono's picture

Finger+porn=climax, sorry for misspelled

t0mmyBerg's picture

Speaking of fingering and porn, if there is a $75 Billion Single White Femaile (SWF) I would like to meet her

bid the soldiers shoot's picture

I 'home' things work out for you

aVileRat's picture

1. Institutional mandates were the biggest fish purchasing equity, not just the Japanese pension funds and Swissy but everyone.

2. SWF's diversified, like Pension plans into the Harvard model where real estate and physical asset speculation was added to portfolios, often in jurisdictions with high net worth (nee: oil money) so while on paper all the SWF's thought they had excellent 'diversification' their property, asset class and return profiles all look like Dubaiworld/KSA holdings, which were prime examples of how a credit event blew out their balance sheets thanks to bad investment analysis.

3. A cursory look at US Retail and US Purchasing Power indicate the large bulk of global retail spending was done not by emerging wealth but by the energy rich or consumer credit. With the inflation cycle imploding both China and the nuveau-rich are retrenching, hard. This means anyone in (2) who speculated on luxury (everyone, including Unicorns like Uber) are now facing some very large questions on growth multiples.

4. As '37 showed, manufacturing is a leading indicator if PMI and Inventory numbers are collapsing. As energy was the largest consumer of Capital Expenditure dollars (financing and trade payables), the slowdown in energy investment is going to impact not just the General Electrics of the world, but everyone down to the General Motors, where Fleet Truck sales to energy outfits and energy governments were the third largest fleet orders behind government contracts.

5. If you are a retail consumer/investor/taxpayer, and you are in or employed in (4), the delay in contracts and possible breaking of support industry contracts to the energy complex is going to risk your own spending habits. When you become aware at just how redundant you, your union and your household is to a non-operating factory (with 3 years of inventory on the lot) you will retrench too, just like the Russian oligarchs. This is a feedback loop on every small business and retail outfit that depends on your local community. As local communities collapse with layoffs & furloughs, populations migrate back to their homelands, which if they too are "have not" states, suddenly we see a rapid escalation in social safety net pressure. See Greece & Spain as modern case studies on when the youth 'come home'.

6. Loop 3 ->5 will feedback until nonproduction clears inventory in everything.Given that the materials industry is still waiting for China to cease export dumping, this will not clear overnight nor over a half-decade without a rapid supply-side shift.

7. While 2 is taking on losses from Loop, you will get increasing risk of a monetary bail-in. Global trade hates these things, just ask 1998 Russia & Hong Kong.

8. Since everyone is in bonds, and we all know how well bond liquidity is going in Japan / USA post-QE3.5, how well do you think someone can exit a Russian bond position. Now how about a Nigerian bond position. Now how about a Nigerian FX swap. I'm using Nigeria as an example, chillax Nigeria.

9. Knowing what you know about 8, review the balance sheets of 1 & 2. Now ask yourself, if you were the IMF and world liquidity is nearing a redline, who the fuck are you going to turn to should 2 or 3 major countries need a rescue package to keep the trade credit functioning. AIIB? Like Brazil has collateral to meet a cash call, lol.

And now you have your answer as to why Pensions & SWF's are in deep shit.


The Real Tony's picture

I still have two properties in Edmonton from deals that fell through trying to sell them. I did sell the majority near the peak in Alberta back in 2007. I thought oil would tank in price about 5 years ago just like the stock market should have done. Sometimes what should happen and what does happen can be two different things.

The Real Tony's picture

I still have two properties in Edmonton from deals that fell through trying to sell them. I did sell the majority near the peak in Alberta back in 2007. I thought oil would tank in price about 5 years ago just like the stock market should have done. Sometimes what should happen and what does happen can be two different things.

buzzsaw99's picture

they'll borrow first. any selling will be outweighed by levered buybacks initially.

arbwhore's picture

<-- Equities have no intrinsic value.

<-- Oil has no intrinsic value.

Stormtrooper's picture

<--Gold has no intrinsic value (since 1971)

Francis Marx's picture

If Saudi's were smart right now, they would talk to Iran and have a "pretend" war with them. That would put oil up to about 80 a Brl. Everyone benefits.

Dead Canary's picture

When a tsunami hits, first the tide quitely goes out. People go out and pick up sea shells.

Just before the big one hits, I see gold and silver dropping. A lot! That's when I back up the truck.

I believe the banks will trigger the crash. If you know when it happens, you can front run the markets. But first, crash PM's.

4 wheel drift's picture

and the fed will raise rates again.....



Sudden Debt's picture

NEVER underestimate the power of stupid :)


Don't forget that they need to create a buffer to try to restart the economy when we're at the bottom. And at 0.25% it's like having nothing so they need at least 3% to have some bullets. How the stockmarket will look like at 3%... well... maybe even as bad as fair valuation! Can you imagine!

4 wheel drift's picture

under "normal" conditions...  no problem...

we are far removed from normal conditions.  raisng rates is insane under current environment...

we need lower taxes, reduced regulations, and the government REMOVED from business activity, with the objective of

creating an environment CONDUCTIVE to be productive.....   that is what is needed NOW...  once you achieve a relatively

stibalized environment (and conductive to create and grow business)..   then you return to 'normal' policies...


as it is....   we are in such a hole that i am not sure what will exactly be that begins to cure this insanity

such statement will NEVER be made by policymakers, because their ego is larger than their arse and will never admit....  'being wrong'

coast's picture

The world is full of kings and queens, that blind your eyes and steal your dreams, they will tell you black is white, and the moon is just the sun at night, and when you walk those golden halls, they will give you all the gold that falls.....  Heaven and hell....ah sabbath....then there is pink Floyd with teacher leaves them kids alone and good bye blue sky and even styx with grand illusion...and the bible,  even the rocks will cry out

Dubaibanker's picture


The world is spinning backwards for the last few years as more and more companies leave foreign shores and return home or shut operations in other nations.

Reasons are lack of business due to massively rising unemployment worsened by currency depreciation which is hurting both importers/exporters and all major investors who did cross border investments in the years gone by... etc.  Lately, due to terrorism tourism is shrinking and bans have been placed due to which global tourism and activity is shrinking rapidly from Malaysia to Turkey and to Middle East including Tunisia, Egypt etc.

Emerging markets will get hurt significantly due to this during 2016 and onwards as large foreign companies not only leave and withdraw investments from emerging markets (Nokia, Foxconn, various banks, mutual funds, insurance companies, telecom, electronics etc are great examples worldwide) and do not invest further causing a double whammy, at a time when most emerging markets are struggling to create employment and making desperate attempts to bring foreign investors.

China bought from GE - one of the largest company's in the world - their appliance unit and thus gained entry into the US market and became one of the largest appliance makers and suppliers in USA!

Last week, China bought the largest movie studio in Hollywood as Americans exit from their own investments.

China is buying real assets instead of junk US Treasury bonds or shares etc. all these assets will provide actual returns which will flow back to China and give China more control over it's investments.

Interestingly, American companies are so weak today that they are now exiting from their own home market! :)

Thousands of jobs have been lost in 2016 and we are barely in the middle of 2016!

More examples of various exits just in the last 10 days:

Wal-Mart to close 269 stores, cutting 16,000 jobs (Largest retailer in the world shutting hundreds of stores)…/wal-mart-to-close-269-stores-cutti…

Wanda’s Legendary Buy Is Just the Beginning of China’s Investment in Hollywood (Largest US movie studio sells itself).

China's Haier buys GE Appliances (GE sells itself)

SABMiller Shuts South Sudan Brewery on Foreign Currency Shortage…/sabmiller-shuts-south-sudan-brew…

Al Jazeera America closing on April 30…/al-jazeera-america-closing-on-april-30/?

GMP to Cut Jobs, Exit U.K., Australia as Commodities Slump…/gmp-to-cut-97-jobs-exit-u-k-aust…

Easy Taxi Exits Asia to Focus on Operations in South America…/easy-taxi-exits-asia-focus-operat…

Lafarge plans to exit India operations…/lafarge-plans-to-exit-in…


Airtel to sell 2 African units to France's Orange…/articlesh…/50569558.cms

Toshiba to exit home appliance, TV business in India as losses mount…/69589806_1_t…

Lonrho exits agriculture unit

Credit Suisse's Monaco unit up for sale: sources

Russia's Lukoil exits projects in Cote d'Ivoire 



Crystal Cruises cancels stops in Turkey over security issues


It is not just that the western companies are leaving other locations. Even the US stock markets are shrinking and the total number of US listed companies, (both US companies and non US) are shrinking!

On top of everything, SWF's are selling equities and bonds putting more pressure than ever before on global equity markets which will cause stocks to keep declining for years to come since this money is irreplaceable and has been spent on non corporate factors or salaries etc and will be very hard to get back into the equity have a major reason to continue declining as 40 year old sticky oil money leaves Western markets.

rbg81's picture

Yeah, but......falling oil prices are good for the "consumer".  Right....right??

The Real Tony's picture

I don't see Canada in the list. Our SWF looks like a well that ran dry decades ago. It looks a lot like the hole in a donut.

Sudden Debt's picture

I wonder who actually wants to buy now as we're crashing as we speak.

How dumb can you be?

kiwimail's picture

I left Alaska years ago when the state was setting up their Alaske Permanent Fund, the state equivalent of a swf.  At the time there was talk of requireing 10% of the assets be held in gold.  Does anyone know if that really happened?