3/10/20 Market Notes
Russia’s refusal to cut oil production in step with the other OPEC+ members prompted Saudi Arabia to start an oil price war. The Kingdom has the lowest production and breakeven cost of any major oil producer, meaning it can be profitable at much lower prices than most. By many accounts the Saudi’s can sell oil at the $30 per barrel level and still make money, while Russia, Iran and many others need oil prices well above $40 per barrel to be profitable. Saudi’s move to cut April delivery prices to about $32 per barrel, and increase production levels to over 10 million barrels per day caused oil prices to crater by 24%, the largest single day down move since 1991. Consequently Treasury prices jumped sharply, driving the yield of the Ten Year Treasury as low as 0.318% before rebounding to end at 0.575%. Gold prices topped $1,700 in late trading, before retreating a bit to close at $1,674 per ounce. Stocks started the day sharply lower and deteriorated from there. By the time the closing bell rang, the Dow Jones Industrial Average lost 2,018 points, the S&P 500 and NASDAQ fell a similar 7 ½%, while the Russell 2000 ended 8.67% lower. On a sector basis, the Energy sector declined a record 20%, as Financials fell 11%, and the Industrial and Materials sectors lost about 9%. The more defensive Consumer Staples, Utilities and Health Care sectors outperformed on a relative basis, losing 4 ½%, 5.65% and 5 ¼% respectively. While some might be tempted to point to lower oil prices as leading to lower fuel costs and thereby benefiting consumers, low oil prices are very problematic for the United States. The U.S. is one of the largest producers of oil and a net exporter of the commodity. As such, low oil prices will likely cause producers to reduce rig counts and push some shale producers out of the market all together. Given that the world’s economies are already facing significant economic headwinds as a result of the coronavirus, the timing of this could push the Unites States economy into a recession – although that probability remains small. What to expect: Remain calm and invested:
Global growth is sure to slow if the current conditions persist, and the U.S. economy is at greater risk of entering a recession like environment (it’s tough to expect 2 quarters of negative GDP growth at this stage).
Expect more policy action from the Fed and other Central Banks: After the March 3rd interest rate cut, the Fed now only has 100 bps of room before entering a negative yield environment, something all FOMC members are very opposed to. More cuts are almost certain, as are other policy steps such as additional liquidity measures, and asset purchase programs.
The ‘lost’ demand as a result of the coronavirus will prove to mostly be pent-up demand. Our research shows that there has been little long-term economic damage as a result of pandemics. During SARS, the Hong Kong economy fell for a couple of quarters before rebounding strongly once infections abated. Even the Spanish Flu in 1918 had short-lived market and economic impact despite the loss of 50 million lives. As such, our changes in the portfolios have been minimal and we remain close to fully invested, taking rebalancing opportunities when possible.
We anticipate both sector and industry performance divergence as well as company specific performance divergence. Specifically, in the first half of the year, we expect those sectors and companies with greater exposure to the coronavirus to experience more volatility and potentially significantly underperform those with less exposure to this potential pandemic. As such, we are underweighting companies that are heavily reliant on China for either their supply chain or overall business revenues.
Watch out for dividend cuts – balance sheet strength and strong cash-flow are king right now. We are reexamining all dividend coverage ratios and remodeling our assumptions based on a zero earning growth environment.
Disclosures: This market commentary is written by the 1879 Advisors and represents the views of 1879 Advisors. This commentary is not investment advice and should not be used as a basis to make investment decisions. Please consult with your registered investment advisor before making any investment decisions.