Daily roundup of research and analysis from The Globe and Mail’s market strategist Scott Barlow
Global markets have been an absolute gong show since Asian futures trading opened Sunday night. Saudi Arabia, unable to cut a deal with Russia to curb OPEC oil production, retaliated by announcing they would flood markets with cheap crude. Global energy companies were already faced with year over year declines in demand according to the International Energy Agency, so oil prices promptly cratered 30 per cent when trading began.
The selling spread throughout markets – the S&P 500 futures contract halted trading after falling the maximum 5 per cent. At time of writing (roughly 7:00 a.m. ET) , S&P 500 futures indicate a 145 point drop (4.9 per cent) at the North American open and WTI crude is trading at US$32.42, down $8.85 or 21.4 per cent.
Goldman Sachs thinks this crude sell-off will be worse than 2014,
“We believe the OPEC and Russia oil price war unequivocally started this weekend when Saudi Arabia aggressively cut the relative price at which it sells its crude by the most in at least 20 years. This … brings back the playbook of the New Oil Order, with low cost producers increasing supply from their spare capacity to force higher cost producers to reduce output. In fact, the prognosis for the oil market is even more dire than in November 2014, when such a price war last started, as it comes to a head with the significant collapse in oil demand due to the coronavirus… we are cutting our 2Q and 3Q20 Brent price forecasts to $30/bbl with possible dips in prices to operational stress levels and well-head cash costs near $20/bbl”
“@SBarlow_ROB Avert your eyes, Alberta. GS: "the prognosis for the oil market is even more dire than in November 2014" – (research excerpt) Twitter
“ IEA predicts global oil consumption will fall in 2020 for the first time since 2009” – Reuters
“'Crazy' Saudi oil price cuts seen reigniting market share war with Russia’ – Yahoo! Finance
“Goldman on why this is worse for crude than Nov 2014” – Bloomberg
““If you ever wondered what would happen if someone lobbed a hand grenade into a bloodbath, now you know" – Financial Times (paywall)
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The biggest shock overnight was the 10-year U.S. Treasury bond trading with a yield below 0.5 per cent. The investor race for safe havens (gold is also up big) has become a stampede. I’m stunned, of course, but don’t think this necessarily signals an imminent global recession. There are factors – central bank intervention and demographic-led demand for income mainly – that make longer term yields less of a gauge of future growth expectations than in times past.
The U.S. 10-year is currently trading at 0.44 per cent and the Canadian ten-year yield is stunningly low at 0.27 per cent. The rally in bond markets makes negative long-term North American yields a foregone conclusion if markets remain weak.
“Here’s Why It Matters That Interest Rates Have Cratered” – Barro, Intelligencer (NY Magazine)
“Why I’m More Worried About the Bond Market Than the Stock Market” – A Wealth of Common Sense
“Reshaped bond markets so far passing biggest liquidity test in a decade” – Report on Business
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I still believe, for now, that a diversified portfolio will be ok in a few months. There are reports that China has been successful in containing the coronavirus so that’s encouraging.
The big worry that would change my view – one that could signal the end of the bull market – is corporate credit spreads. Corporate debt expansion has been explosive in the past decade as ultra-low borrowing costs allowed for share buybacks, balance sheet re-jigging that increased profit growth, and financed the proliferation of shale drilling. The risk at this point is that bond spreads widen out, threatening the solvency of companies dependent on cheap money. Specifically, there is a lot of high yield energy company debt that could possibly default because of the plunge in crude prices. Domestically, oil sector defaults would be an obvious problem for bank profitability.
The Financial Times reports,
“”This was literally the last thing US high-yield energy producers needed,” said John McClain, a portfolio manager at Diamond Hill Capital Management, referring to the effects of the move from Riyadh on junk-rated companies. “There will be blood in the market on Monday” … Energy companies are the biggest issuers of junk bonds, accounting for more than 11 per cent of the US high-yield market. Such issuers have credit ratings of BB or below, indicating that they are at higher risk of default than “investment-grade” issuers, rated BBB and above.”
“Oil price war spells danger for US junk bonds” – Financial Times (paywall)
“Reshaped bond markets so far passing biggest liquidity test in a decade” – Report on Business
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Diversion: “How ‘Contagion’ Belatedly Became a Disturbing Rewatch” – The Ringer (podcast)
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