Oil price collapse is a wake-up call for stock markets

Any idea that economies are through the worst of coronavirus seems misplaced.

AFR

Apr 22, 2020

Katie Martin Contributor

The collapse in oil prices is a warning. Anyone who has been swept up by the rally in stock markets since late March would be foolish to ignore it.

Even by the standards of the past couple of months in markets, the sheer scale of the fall in oil has been breathtaking. For the first time ever on Monday, it turned negative. Having started the day at about $US10 per barrel, prices for West Texas Intermediate, the US benchmark, tied to delivery of the black stuff in May, cratered to minus $US40.

There is so much oil sloshing around, so little demand for it in a global economy in lockdown, and so little space left to store it, that sellers are paying buyers to take it off their hands. Bloomberg

That means there is so much oil sloshing around, so little demand for it in a global economy in lockdown, and so little space left to store it, that sellers are paying buyers to take it off their hands.

Optimists were quick to argue that this is just a market technicality. Short-term storage problems are simply pinching this particular contract in this particular part of the world, they said. They noted that it is not unusual for so-called front-month prices to drop below the cost of oil to be delivered at a later date. In other words: nothing to see here.

But that looks like the financial markets equivalent of arguing that coronavirus is “just the flu”.

A barrel of oil changing hands at -$US40 is simply not normal. What is more, prices of oil for delivery at other times of the year, and from other parts of the world, are now plunging too. Prices for WTI for delivery in June tanked by as much as 40 per cent on Tuesday. It turns out that the world does not much want that oil either.

This is a wake-up call. Since late March, stock markets and riskier bits of the bond market have been rallying, dragged out of the depths of despair by heavy-hitting central banks.

The US Federal Reserve has pledged to buy a huge range of bonds, and is even supporting the high-yield debt market. This pulls down bond yields and encourages investors to snap up equities, which they have duly done. The Fed is not, however, buying oil.

It is perfectly reasonable to buy stocks on the basis that the Fed has your back, and most fund managers would agree that central banks have succeeded in neutralising threats to the financial system itself. But any idea that this is an organic recovery, that companies and economies are through the worst and gliding smoothly back to normal, seems misplaced.

The fall in oil is one of the markets’ simplest, cleanest ways of saying that the global economy is in deep distress.

Yes, as some bravely upbeat investors are keen to point out, the slowdown of the spread of the virus in some parts of the world is encouraging. But on its own, it is not encouraging enough to support a 26 per cent jump in the S&P 500 benchmark of US stocks over the past month.

As Goldman Sachs’ chief global equity strategist Peter Oppenheimer warned this week: “This rally in equity markets is probably too far too fast, and there are probably still downside risks from here.”

The fall in oil is one of the markets’ simplest, cleanest ways of saying that the global economy is in deep distress, and that manufacturers and airlines and households are not expecting to get back to business any time soon.

In turn, this suggests that investors remain too optimistic about the speed and force with which companies and economies can rebound from the lockdowns designed to keep coronavirus at bay. After all, the S&P is now back to where it was last June.

“The second quarter is going to be awful for earnings,” said Karen Ward, JPMorgan Asset Management’s chief markets strategist for EMEA. “We think the market is still a little bit optimistic  . . . . That’s the thing that concerns me.”

Anyone still buying the dip in risky assets, and refusing to hear the argument for another leg lower, should listen out for the dull thud of oil traders banging their heads on their desks.