It was another volatile day for equity markets yesterday with oil front and centre, given its continuing collapse.
In the UK, the FTSE-100 ended the day down just over 170 points, or nearly 3%, while on Wall Street, the Dow Jones fell over 600 points, or 2.67% and the S&P 500 fell 86.6 points, or just over 3%.
West Texas Intermediate (WTI) for delivery in June fell just over 40% to $11.57 a barrel, having been down nearly 70% at one point during the day; while Brent fell nearly 25%, to below $20 a barrel for the first time since 2002 as everyone has finally started to realise that the world is running out of storage places.
Unfortunately, as a by-product, this lower oil price is dashing hopes of an economic recovery. This is because, historically, a global economic downturn resulted in lower demand for oil, and as a result lower oil prices – hence this week’s dramatic oil price fall has raised concerns of a sharp and prolonged economic downturn.
However, we believe that this playbook is wrong.
Yes, the coronavirus outbreak and associated lockdowns has resulted in lower demand for oil (as we have previously stated, global demand has probably fallen from around 100m barrels a day to below 75m as planes are grounded and factories have closed), but this selloff is different because supply is completely overwhelming the markets as OPEC mistakenly decided to increase its supply at a time when demand was contracting – and this massive and sustained oversupply was only going to result in carnage.
Consequently, once the markets realise that we have a supply issue, not a demand issue (because the coronavirus outbreak is a transient issue), then this correlation between oil prices and global economic growth (and in turn equity prices) can be broken – which will be positive for global equity markets.
In fact, as we have previously stated, we believe that a lower oil price is a positive, because once this horrible outbreak is contained, companies will be operating in a world full of cheap input costs, thanks to the lower oil price – in fact, it can be likened to the equivalent of a tax cut.
Although in the longer term, the oil market will be able to rebalance itself, as oil producers will likely be forced to cut production due to the lack of storage capacity while demand will recover, but these things take time so the low oil price is here to stay for the time being.
Additionally, this lower oil price is already starting to show itself in inflation. Data released this morning showed that UK CPI inflation, slowed to 1.5% in March from 1.7% in February – and we would not be surprised to see UK inflation quickly drop to below 1%.
Global equity markets have thankfully opened up this morning after the US passed a new $484bn coronavirus relief package, coupled with news that cases may be flattening in a number of US states, suggesting the lockdowns may soon start to be lifted. As we write the FTSE-100 is up just over 1%, or 60 points at 5,700.
Investment Management Team