Sinking into the Oil By: Gabriel PotterMBA, AIFA® 2020.03.09

Monday was already shaping up to be a pretty bad day in terms of trading.  The coronavirus and its direct effects have been the catalyst for some pretty terrible trading days over the past few weeks, but the bad news kept coming.  Today’s tremendous plunge is influenced by the coronavirus to be sure, but the real impetus for today’s massive sell-off is the price of oil.  Today may end up being the worst drop in price of both oil and energy sector stocks ever recorded.

So, what happened?  Here’s the short version: talks within OPEC, the oil producing cartel, broke down and oil producing nations are drilling as much as they can without collaborating.  A price war is breaking out between Saudi Arabia and Russia. The price of oil fell 31% on Sunday evening.  While cheap energy is good in the long term for global consumers, it is still a shock that has to be managed.  It has been several years since the price of oil tanked, but long-term clients of ours may remember monthly newsletters and blogs from the 2014-2015 era where we walked through the impact of cheap energy on US stock market performance.

First, net energy producers, like the United States, have to bear lower imputed future revenues.  Second, there are material financial liabilities (i.e. high yield bond issuances) embedded in the energy exploration, production, and distribution business; payment on these bonds is now suspect.  Third, it’s simply a reflection of low economic circulation.

It has been a long time since there was anything like fear present in the market, but it is back.  As evidence to the fact, consider the 10-year treasury yield.  Treasury bonds are widely considered a safe investment and investors tend to flock to them when times get bad.  As investors dump money into treasuries, the amount of yield it needs to generate to attract investors gets lower and lower.  Thus, when treasury yields fall, it’s a sign of pessimism.  Over the past few weeks, it was significant that the 10-year treasury yields hit all-time lows, just under the psychologically important mark of 1%.  In the past 24 hours, 10-year treasury yields have imploded, hitting 0.318%.  That’s what fear looks like. 

 

 

 

 

 

Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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