May 4, 2020
May 4, 2020
- Even with the recent chaos in the oil markets, the outlook for the energy sector overall remains strong
- The bear market rally is starting to fizzle out, but more ebbs and flows — some more jarring than others — are expected over the next two quarters
- The rally was mainly driven by tech and healthcare stocks, which are not necessarily representative of the broader economy
One Big Takeaway
The worldwide economic shutdown from the coronavirus pandemic, following a price war between Russia and Saudi Arabia at the beginning of the year, have created a perfect storm of turmoil in the oil markets that is leaving investors unsettled. Current estimates suggest demand will drop by at least 30%, creating an increasing glut. OPEC has scaled back production, but only by 10%.
With space to store the newly-produced barrels running out, the futures market must now contend with uncertainty on the demand side — as has been widely reported, getting “back to normal” could take years — as well as the unusual question of where the unused oil can be stored. Intermediaries such as the United States Oil Fund exchange traded fund (USO), have begun paying buyers to take the barrels. All of this creates a spillover effect for contracts in June, July, and so forth.
Is there a safe haven in the oil market right now? Well-established oil producers are better positioned to weather volatility and are also more likely to have R&D investments in other energy sources that could become part of the “new normal” in the longer term, although such projects are likely to be delayed in the short term.
The energy sector as a whole has a relatively robust outlook, as do the health and technology sectors, that we will continue to monitor as the pandemic responses and resolutions unfold.
Chart of the Week
Stability is a relative term these days, but companies with an established market presence and significant cash reserves are better positioned to hold steady amid chaos. The oil majors autocall product launched by Hinduja Bank in March, which includes
Royal Dutch Shell, BP, and ExxonMobil, began trading at 100 and currently sits at 98. The stock prices for the largest oil companies are not immune to the market fluctuations, but have not experienced the same dramatic changes as the oil price per barrel.
With more than 85% of Indians of working age employed in cash-based, informal sectors like carpentry and farming, a huge segment of the population is not tracked in GDP. This makes it unclear how these informal sectors—and therefore, the economy—are actually faring in the pandemic. An extended lockdown will likely weaken India’s economic momentum over the coming quarters and create further headwinds for corporate earnings. At the bottom, Indian equities were factoring in a 25% drop in earnings per share, and posted one of the worst performances in Asian equities from their Feb. 20 peak. Investors interested in Indian equities are well advised to take a selective approach and focus on companies with strong cash flows and balance sheets, such as in the technology sector.
Preventing a European debt crisis
As Italy’s borrowing costs continue to rise, the European Central Bank is scrambling to head off a regional debt crisis. Italy’s “spread” from Germany’s 10-year government bond yields is now at 2.6% —only slightly below the 2.8% sell-off peak in March, a risky indicator for a country that was hit especially hard by the virus. Members of the ECB general council appear to be coming on board with bank president Christine Lagarde’s insistence that the already-aggressive quantitative easing measures need to ramp up.
Data to Watch
- To help businesses get the cash they need to stay afloat, the Bank of Japan decided in its abbreviated April 27 meetingto expand the purchase of commercial papers and corporate bonds and lift the ceiling on government bonds. The Nikkei stock index jumped 2.4% at the news; any sustained bounce will be dictated by the plan’s implementation as well as the virus’s trajectory.
- The U.S. Congress agreed on an additional $480 billion COVID-19 relief package, including $320 billion in small business loans. However, Senate Majority Leader Mitch McConnell (R-KY) wants future fiscal stimulus to wait until the legislative body is back in session on May 4. Members from both political parties are pushing for an earlier start date.