Coronavirus, Oil Prices, and an (Almost) Bear Market in Stocks
Eleven years ago, on March 9, 2009, the U.S. stock market reached its low point of the Global Financial Crisis. That dark day marked the beginning of an extended bull market that took the S&P 500 Index from 676.53 to 3,386.15 on February 19, 2020 – a 401% increase. Over the last three weeks, we’ve witnessed a sudden reversal. After today’s dramatic 7.6% market drop, the S&P 500 now sits at 2,746.56, a 19% decline from the recent high. Stocks have now given back the significant gains they made over the last 12 months and are on the verge of the 20% decline that defines a bear market.
In search of safety, nervous investors have piled into government bonds, driving prices up and yields down to historic lows. The benchmark 10-year U.S. Treasury bond now yields just 0.57%, substantially less than most money market funds. Even the 30-year U.S. Treasury yield has plummeted, briefly trading under 1% this past weekend. U.S. investors have observed negative bond yields in Japan and Europe with curiosity for years, but we now find ourselves not far from that strange territory.
The precipitous stock market drop on March 9, 2020 was partly attributable to the ongoing spread of COVID-19 (coronavirus) and its deepening economic impact, but also due to an unprecedented cratering of oil prices. Energy-dependent economies worldwide now find themselves under enormous pressure, adding to the uncertainty in financial markets.
The heightened volatility in financial markets and ominous headlines are concerning to all of us. Markets have often rebounded quickly from short-term scares in the past, but is this time different? The short answer is that nobody knows for sure, but here are some of our current observations:
The spread of COVID-19 is causing worry among governments, companies, and individuals about the health of the global economy. It appears increasingly likely that the U.S. and many other countries will experience a recession in 2020, largely due to decisions driven by COVID-19 concerns. Airlines, hotel chains, and cruise lines have been hit hard as non-essential business trips and vacations are cancelled or postponed. Conferences, conventions, and music festivals have been called off, and companies have increasingly accommodated employees working from home, while simultaneously dealing with interrupted supply chains. The aggregation of these decisions will cause short-term economic pain, but we anticipate that these tactics will slow the spread of the virus, enabling health care systems to absorb the COVID-19 caseload. We also believe that as economically disruptive as COVID-19 currently is, and as widespread and tragic as it ends up being on a human level, its direct impact will likely be felt over the next few months rather than the next several years—good news for the economy and financial markets.
Oil prices fell nearly 25% over the weekend as a price war emerged between Russia and Saudi Arabia. After Russia refused to adopt OPEC-proposed production cuts last week, Saudi Arabia retaliated on Sunday by lowering the price of Saudi oil and expanding its production. Although low oil prices typically lead to lower fuel prices for consumers and transportation companies, low prices adversely impact economies—and companies—that rely on energy production. The Vanguard Energy ETF, which tracks the broad energy index involved in oil, natural gas, and coal, fell nearly 20% today. Companies involved in shale oil production (“fracking”), many of them in the U.S. and Canada, will be especially affected by a sustained drop in the price of oil, since their production costs are much higher than those of traditional wells and many of them rely on debt financing. If oil prices stay low, we will likely see bond defaults and bankruptcies in this part of the market. But it is important to note that the energy sector is just 3% of the S&P 500 market capitalization, meaning that large changes in stocks like ExxonMobil, Chevron, and Occidental don’t move the overall stock market the way they used to. It remains to be seen whether Saudi Arabia will stand by its decision to lower oil prices, or if OPEC member countries and Russia will return to the negotiating table to hammer out a compromise.
As jarring as recent market turbulence has been, patient long-term investors understand that periods of short-term volatility are inevitable and don’t overreact to them. The future certainly appears less bright than it was a couple weeks ago, and stock prices have quickly adjusted to reflect that “new” version of the future. The market will continue to adapt to fresh news in the coming days, weeks, and months. (This concept is known as market efficiency.) Whether the market has got it “right,” or perhaps has undershot (or overshot), is something we will only know after-the-fact. We can’t tell you when things will turn or by how much, but our expectation is that bearing risk today will be compensated with positive expected returns in the future. We have no reason to believe otherwise.
Please do not hesitate to contact your wealth advisor if you’d like to discuss your portfolio or overall financial situation.