In this week’s market update: The oil price turns negative for the first time as demand slumps and storage fills to capacity; energy heavy stock markets weaken in sympathy; earnings season accelerates as a fifth of S&P500 companies report; and the economic impact of the coronavirus outbreak becomes clearer.
Oil was grabbing all the market headlines at the start of this week as the price of crude first fell to its lowest level for 20 years then briefly dipped into negative territory for the first time. That means that oil producers were paying traders to take oil off their hands as storage fills up in the face of a plunge in demand.
The US WTI contract was hardest hit with the price of oil for May delivery hitting minus $40 a barrel at one point. That contract expires today and no-one wants to hold oil when there is nowhere left to store it. The market is awash with supplies as demand is hit hard by the lockdowns that countries have implemented to counter the spread of Covid-19.
With the May contract expiring today, this was always going to be a short-term technical dip into territory and the WTI price rose marginally above zero on Tuesday morning. But attention is shifting to the June contract with storage likely to be a problem in a month’s time too if there is no pick up in demand. Brent, the international counterpart of WTI, is trading at around $26 a barrel, also well below its level earlier this year of around $70.
The latest drop in the oil price means the cost of crude is now lower than at the two low points of the past 20 years, following the financial crisis and during the China-fuelled slowdown in 2015.
The fall in the oil price has come despite belated attempts by big oil producers to cut production by around 10%. The 10m barrels a day production curbs by Saudi Arabia, Russia and other members of the so-called Opec+ group attempts to reverse a deliberate attempt in previous weeks by these big suppliers to flood the market with oil to pile pressure on North American shale oil drillers.
It was always a big gamble for the Saudis and Russians to take on the Americans at a time of plunging demand and their U-turn confirms a need to push the price higher to balance the books in these energy-dependent economies.
A fall of a third in the number of active rigs in America suggests the Saudi/Russian approach came close to achieving its goal but the scale of the economic downturn was simply too much for the market to bear.
Stock markets with significant energy sectors, such as the UK, were hardest hit on Monday with share prices eating into their recent gains. Markets have enjoyed a robust rally since the last week of March as investors have chosen to focus more on massive policy stimulus than growing evidence of a worldwide economic slowdown.
The rise in share prices has pushed valuation multiples back to levels seen before the February market correction began thanks to widespread reductions in profit forecasts as the true cost of the lockdown starts to be factored into analysts’ models.
Sentiment has been hit by a series of gloomy predictions from the likes of the UK’s Office for Budget Responsibility (OBR) and the International Monetary Fund. The OBR said last week that the UK economy could shrink by 35% in the second quarter and by 13% for the year as a whole. This could see unemployment growing to 2 million and result in a doubling in the government’s budget deficit to 14%.
Meanwhile the IMF warned that global growth could fall to minus 3%, a reversal of its previous forecast of plus 3.3%. Developed economies are forecast to shrink by 6% while emerging economies will stagnate.
The scale of the likely falls in output have created massive uncertainty in the economics profession, with the gap between the most optimistic and most pessimistic forecasts wider than at any point in modern history. Participants in financial markets are having to accept that they are flying blind at the moment, with forecasts incorporating a wide range of outcomes from a V-shaped plunge in activity followed by rapid recovery to a U-shaped trajectory of decline then shallow recovery or even an extended period of flat activity at a low level.
Other records to have been set in recent weeks include the highest government stimulus packages in peacetime history. Only the boost to spending in the second world war exceeds the current level of public investment as a proportion of the size of the economy. Governments have taken to heart the lessons of 1929 and 2008 that only quick and massive spending can avert catastrophic economic outcomes like the Great Depression of the 1930s.
A study from McKinsey, the management consultancy, this week suggested that one in four jobs in Europe, 59 million in total, could be at risk from the corona-crisis. The report defines at risk as being vulnerable to cuts in pay or hours worked, to temporary furloughs or permanent lay-offs. Meanwhile in the US, more than 20 million workers have signed on for jobless benefits in recent weeks.
Although the European jobs market has not seen the scale of redundancies experienced in the US in recent weeks, it is likely to be slower to recover than the more flexible US where jobs are easier to switch off and back on again. It is estimated that unemployment in Europe could top 10%, with memories still raw of the 10 years it took for European jobs markets to recover from the post-financial crisis slump in employment.
Different sectors are more at risk than others. Food and accommodation, travel and tourism, and arts and entertainment are seen as being at particular risk. By contrast professional services looks to be less affected. The McKinsey report forecasts a bigger burden will be borne by younger workers and by those with fewer qualifications.
Evidence of the pressures on the airline industry also mounted this week. Japan’s biggest carrier ANA said it would make a fourth quarter loss of $550m, Norwegian said four Swedish and Danish subsidiaries had filed for bankruptcy, putting 4,700 jobs at risk, while Australia’s second biggest airline Virgin Australia warned it was going into voluntary administration after failing to secure a government bailout.
The impact of the slump in economic activity on corporate earnings will start to become clear this week as the first quarter results season starts to accelerate in America. Around a fifth of S&P 500 companies are due to report results this week.
The numbers they announce and the commentary from management that accompanies the figures will provide a pointer to the sustainability of the stock market rally over the past couple of weeks. The recovery in prices has reflected increased investor optimism that governments and central banks have their backs via massive fiscal and monetary support packages. But sceptics point to similar ‘bear market rallies’ in previous market downturns such as the 25% rise in prices in late 2008 before markets tested new lows in early 2009.
The reality is that few company managements, let alone analysts, have any idea how big the impact will be. There are too many variables - medical, economic and financial - to know how low profits
can go. We don’t know when and how quickly economies will emerge from lockdown, we don’t know how many jobs will be lost or how quickly they will return, we don’t know whether we will revert to the old ways of working and consuming, we don’t know whether and on what terms companies will be able to fund their businesses - to take one example, cruise company Carnival has gone from borrowing at 1% to 11.5%. Ford recently had to pay 10% to find buyers for a bond, three times what it had to pay two months ago.
What is also unclear is just how real the market rally is given its dependence on the performance of a relatively small number of companies. According to Bank of America, 22% of the value of the broad US market is accounted for by just five companies: Microsoft, Apple, Amazon, Alphabet and Facebook. This concentration is much higher even than the technology focus of the market in 2000 when Microsoft, GE, Intel, Cisco and Walmart accounted for about 18% of the US market.
It is estimated that four out of every five US quoted stocks is still in a bear market despite the torrent of government and central bank stimulus. The struggles of the majority of companies are better illustrated by the underperformance of banks and smaller companies and the failure of government bond yields to lift off the floor. While these suggest difficult times ahead for the economy, they also point to a lack of over-exuberance outside of the Silicon Valley bubble. This provides a glimmer of hope that most shares may have fallen enough.