Our Perspective on Oil and Stocks' Continued Volatility

Ouch. That is the first word that leaps to mind after Monday’s big market volatility. By now you likely know stocks plunged globally after Saudi Arabia flipped from trying to agree to production cuts to slashing its oil price and ramping up output. That sent global crude oil prices down -30% this morning, before they recovered somewhat.^[i] The S&P 500, meanwhile, fell -7% early in the day, triggering circuit breakers that paused trading for 15 minutes to give everyone a moment to breathe and try to think rationally. After trading reopened, stocks seesawed and ultimately closed down -7.6% on the day.^[ii] That brings the S&P 500’s peak-to-trough decline to -18.9%, placing it inches from what many consider bear market territory on what would be (and we think will still prove to be) this bull market’s 11^th birthday.^[iii] It is ugly any way you slice it. However, this volatility still looks correction-like, not bear market-like, to us. While there is no way to know how much longer this volatility will continue, we still think investors seeking long-term growth will benefit most from staying cool and awaiting the recovery.

In our view, that remains true even if volatility continues and takes the total decline somewhat below -20%. Whatever you call such a move, quick, steep drops tend to reverse about as swiftly. Absent a major, lasting, fundamental negative—which we don’t think coronavirus fears or weak oil prices amount to—the rebound shouldn’t be far off.

The general sentiment among investors today seems to be that plunging oil prices add another blow on top of the coronavirus, all but assuring a global recession. In years past, investors would have cheered oil prices in the $30s as stimulus, arguing it gives consumers more flexibility to spend on discretionary items. But in 2014, the last time oil plunged, it didn’t have a material effect on consumer spending, and it forced oil firms to rein in investment. Their cutbacks rippled through oil-dependent economies as well as global manufacturing, causing a mid-cycle economic slowdown that lasted into early 2016. As a result, people are now penciling in another round of cutbacks—and worse. Many smaller Energy producers have weaker balance sheets now than the last time around and risk running out of cash if they can’t continue tapping borrowers, causing a twin fear of bankruptcies wreaking havoc in the sector, potentially triggering a chain reaction through broader credit markets and the economy.

We won’t comment on the geopolitics surrounding the apparent oil price war—they are mostly speculation at this point and probably immaterial to markets, which care most about supply and demand. The why doesn’t matter as much as the reality of changing supply drivers. OPEC and Russia’s joint efforts to curb production seem over. The impact on global supply will depend on how American (and to a lesser extent Canadian, British and other market-driven producers) firms respond to the shifting financial landscape. Will they put the past few years’ worth of efficiency gains to work and keep pumping in hopes of retaining market share? Or will they hunker down? Only time will tell.

As for the broader market, we haven’t changed our viewpoint: This looks like a panic driven by emotions and speculation, not rational thinking. By our back-of-the-envelope math, Monday’s drop wiped about $1.9 trillion off the S&P 500’s market value. Ask yourself: Has anything fundamentally changed to warrant that? Did $1.9 trillion of potential corporate damage just arise without warning? After surveying the landscape carefully, we don’t think so. As discussed Friday, we still think the market’s reaction to the coronavirus is out of proportion with its likely fallout. As for oil, the last time prices crashed, services industries held up fine. Many benefited from lower operating costs as energy got cheaper. Some retailers got a boost when people didn’t have to spend as much on gas. Manufacturing, oil drilling and adjacent industries struggled, but the services sector is much larger than those industries combined, and it pulled the country along.

Some argue the coronavirus changes the calculus this time. We don’t disagree, but we still think the impact should be temporary. Yes, there are a lot of high-profile headlines. Canceling or delaying the South by Southwest festival in Austin, the Indian Wells tennis tournament in Southern California and Emerald City ComicCon in Seattle will undoubtedly have local consequences. It is also frustrating for all the attendees, athletes, artists and performers, many of whom will be out at least some travel expenses. Tourism more broadly is also in a rough patch. But retailers are likely benefiting from higher demand for consumer staples. Rock-bottom mortgage rates are fueling housing demand, potentially adding a modest tailwind to that sliver of US GDP. We aren’t saying these silver linings will fully offset any short-term hit—it seems reasonable to expect some negative data in the weeks ahead. But we offer them as a reminder that the entire US economy hasn’t come to a screeching halt. Even in areas where the virus has popped up, which some of your friendly MarketMinder editors happen to live in, people are largely going about their daily lives, albeit with caution and hand sanitizer.

What matters most for investors: Stocks are forward-looking, and they move most on the gap between expectations and reality. Market volatility has caused investors’ economic expectations to plunge. Headlines are full of warnings about unending global recession as the world allegedly rethinks globalization and central banks run out of ammunition. Against this backdrop of dread, a few months of lousy data and some isolated GDP contractions would probably be a positive surprise—not nearly as bad as feared. In the last mid-cycle slowdown, everyone worried struggling petrostates and weak manufacturing would combine to end the global expansion. Stocks began recovering well before the data disproved those fears.

So look forward—not just to tomorrow, but to the next several months and beyond. This is where stocks look. Carefully consider the question: Is the damage to stock markets commensurate with the likely economic damage—or is it worse? We suspect stocks have overshot by quite a distance, likely teeing up a recovery as investors gradually realize the panic was unwarranted. Making a move now risks getting whipsawed by the recovery. If your investment goals require long-term growth, participating in the recoveries that follow corrections is generally vital. In our view, those who can stay patient through these difficult times will benefit more than those who handicap their future returns for the sake of avoiding volatility in the here and now.