This week we saw some of the biggest daily falls in asset markets ever, triggered by a disagreement between oil majors Saudi Arabia and Russia and exacerbated by growing concerns regarding the impacts of coronavirus.
Whilst most would’ve noticed the big drop in equity markets, with the ASX all ordinaries dropping 11.10% on 10 March, the bigger falls came in other more critical parts of the market, with oil down more than 25% and government 10-year bond yields down more than 40%. These are some of the biggest daily moves we’ve ever seen.
The Dow Jones (US Equity market) opened more than 6% down and then breached the 1st automatic market cut-off level of 7%, which results in the market closing for 15 minutes. Oil was down another 20%, with the US 10-year bond below 0.50%.
Investors were concerned by firstly the failure of OPEC and the Russians to reach a deal with oil production cuts to help lift the oil price but were then troubled by the Saudis move, to instead increase production significantly and then also significantly discount prices on contracts already in the market, effectively declaring a non-combat war on the Russians. The Saudis are in a position to produce oil at any price in the short to medium term, but at current prices will make it almost impossible to finance their budget. The move will financially cripple the Russians and the US shale oil/gas industry almost immediately. A deal is there to be reached to reverse the ridiculous decision made by the Saudis.
Market sentiment wasn’t helped by increased Coronavirus fears, with Italy taking extreme measures in locking down the whole of the country - some 60 million people in quarantine, following a spike in the number of cases and deaths.
The main concern remains the oil price shock and the potential impact on sub-investment grade debt.
Regardless of a Saudi / OPEC / Russia agreement, this week’s moves will need to be met by strong fiscal stimulus by governments globally to combat the short-term impacts of Coronavirus, and increased support and confidence from central banks not via rate cuts but rather via increases to lines of liquidity and their overall balance sheets (ie. money printing or QE). Whilst rate cuts won’t necessarily help current sentiment, we are likely to see further rate cuts from the central banks, with the Fed possibly skirting another emergency rate cut of 0.5%.
What should investors do?
At this stage, nothing.
Selling into this panic is the worst mistake you can make, especially when you consider that the oil price war is likely to be temporary, as with the impacts of Coronavirus. The December and January market and economic data, before Coronavirus, showed global economic growth was stable and asset prices didn’t appear to be too far above fair value.
Putting cash to work is an incredibly difficult call to make once broader market panic has set in, even for those with a long-term perspective. At this stage, we’d be sitting still until we see some of the panic start to subside. Once that happens, there will be plenty of value to be had for long term investors, especially with cash at 0% and 10-year bond yields at 0.50%.
On the oil price shock
The market has taken an aggressively negative stance on the oil price falls largely because they were completely unexpected and not in anyone's risk model. Plenty of risk modelling globally on an inflationary oil price shock, but no one had been modelling a deflationary oil price shock, given the actors at hand (OPEC and Russia) significantly damage their economies as these oil price levels e.g. the Saudis have a US$80 breakeven to finance their budget. Hence, the market in freefall with calls for oil at US$20 by Goldman Sachs, calls for US Fed at 0% and calls for US recession etc. is just feeding the bears!
The financial and economic impacts of Coronavirus are almost impossible to estimate. Companies have stopped providing earnings guidance, as they should, and we won't know how bad the numbers are until we get them. But, this is not a structural issue - it's a temporary issue that will subside once countries have the right testing and protocols in place, and once the northern hemisphere starts to get warmer weather. The flip side is that once it does subside, there will be more monetary and fiscal stimulus in the system than we've ever seen before! That means the recovery, once begun, should be rather swift.
From a medical perspective - the following should dispel the significant amount of fake news in the system:
- There have been 114,223 cases since the virus began and a little over 4,000 deaths, with almost 63,000 recovered.
- There are 47,000 active cases, of which 87% of people are in a mild condition and 13% in serious or critical.
- The number of daily new cases and new deaths in China is declining, whilst the rate for both is escalating outside of China.
- The death rates vary per country, but the best like for like comparison we have is South Korea - most of the population has been tested, and the death rate is 0.6%, with a sufficiently well-supported government response and hospital system.
- Fatality rates are as follows:
a. 80+ years old - almost 15%;
b. 70-79 - 8%;
c. 60-69 - 3.6%;
d. 50-59% - 1.3%;
e. 40-49 - 0.4%;
f. below 40 - 0.2%;
g. below 9 years old - no fatalities.
- Of those aged 50 and over, in almost all cases, deaths have occurred due to pre-existing conditions, including Cardiovascular, Diabetes, Respiratory Disease, Hypertension, Cancer.
- For those aged under 60 years of age, with no pre-existing conditions, the symptoms vary from slightly better to slightly worse than the common flu.
Information credited to Chris Lioutas.