Stocks fell hard, accompanied by an oil price disaster, likely more a reflection of the futures market, not necessarily the current supply glut. More broadly, the discrepancy between the expected economic recovery and the quick stock market recovery is now a slight concern to many on Wall Street.
All three major U.S. indices fell Monday, with the S&P 500 down 1.79%. The price of oil fell 286% to negative $37.38 a barrel, which technically means an oil producer looking to sell a barrel today would have to pay the buyer $37.38.
The 9.7 barrel per day production cut agreed on by OPEC has been seen as a disappointment compared to the 20 million expected, while demand is destroyed by the Coronavirus. But fundamentally, the price of oil wasn’t expected to fall this much. Hedge funds leveraged against commodity contracts had to drastically reduce their positions, a dynamic among several in markets betting on oil prices.
Smaller oil companies have seen their stocks hurt more than than larger ones have been, as the smaller companies have more debt relative to their expected earnings streams.
Occidental (OXY) - Get Report shares fell more than 7%, while Chevron (CVX) - Get Report fell more than 4%. Oil prices could soon head positive again and Occidental, like its smaller peers are down more than 60% year-to-date.
As for the broader market, when oil prices are at healthier levels, the price remaining low is a tailwind to consumers’ pocket and it keeps fuel costs for airlines down. But with oil prices at such low levels and the U.S. a far larger producer of oil than it was several years ago, U.S. stock investors want to see the price of oil at a healthy level. Oil companies have had to reduce capital expenditures, a negative sign when it comes to employment. The threat of bankruptcy in smaller producers, which some have flagged as a concern, is furthering the worry regarding what has already been an ugly employment picture.
Wall Street is highlighting other risks though, as the oil demand destruction has already been known for some time now.
It’s now evident to some that that V-shaped, or quick economic recovery is very threatened by potentially slow lockdown eases. Meanwhile, the market has looked past the lockdowns and begun to price in 2021 earnings, which should provide a nice rebound against 2020. But some are still warning against elevated valuations. The average stock on the S&P 500 trades at 19 times expected 2020 earnings, leaving the market vulnerable to any bad news on the virus and lockdowns.
One strategist cites the yield curve as one of several indicators that the recovery may not be so smooth. The spread between the 2 year and 10 year treasury yields is 41 basis points, which is low, signaling investors are paying almost the same price for a 10 year treasury bond as they would pay for a 2 year bond, signifying fear that inflation and economic demand will remain weak for a while. The 10 year yield is at 0.63%.
Here’s what Wall Street said about Monday’s action:
Scott Knapp, Chief Market Strategist, CUNA Mutual Group
"Theoretically, suppliers will have to pay consumers to take the commodity off their hands. In reality, moves in the futures markets probably indicate a different dynamic, including a possible unwinding of heavily leveraged position(s) by hedge funds and certain ETFs. The actual spot price of a physical barrel of oil will likely not go negative. Any way you look at it, this is a meaningful disruption that could indicate broader distress in markets and the economy.”
Brian Price, Head, Investment Management, Commonwealth Financial Network:
“With oil prices close to all time lows, that threatens some of the big oil companies based here in the U.S. and these companies employ a lot of people. Think about the state of Texas and all the oil workers employed in Texas. Are those companies able to stay in business and do they have to lay off thousands of people?”
Mike Wilson, Chief U.S. Equity Strategist, Morgan Stanley:
With risk assets now overbought the chance of a correction has increased. In S&P 500 terms, we believe the index will find strong support at at the 200 week moving average, or 2,650. Likewise, should markets continue to look through the near-term bad news on earnings, it should face resistance at the 50-week moving average, or 2,995. Keep in mind that the highest quality companies tend to have the highest expectations which makes their stocks potentially more vulnerable to the bad micro news. we expect for most companies.”
Lauren Goodwin, Economist, Multi-Asset Strategist, New York Life Investments:
"The reality, though, is that most of the country will remain on lockdown for some time, with a slow and potentially non-linear return to work plan. As a result, we are wary of following market bulls into this rally. We are underweight U.S. equity and credit in our portfolios.”
Tony Dwyer, Chief Market Strategist, Canaccord Genuity:
“The hope is that once we reopen the economy there should be a “v” shaped recovery that could drive stocks even higher as the economy and earnings per share recover. Market “V” call may be too early. The U.S. treasury yield curve can signal end of recession — so far it’s not. Over the three [economic] cycles [dating back to 2001], the spread [2 year treasury to 10 year] reached well over 200 basis points, with 2001 and 2008 reaching basis points before we exited recession. We are hard-preset to come up with a scenario that brings the spread to that level in the current environment.”
Jason Pride, Chief Investment Officer, Private Wealth, Glenmede:
“The blended year-over year earnings growth estimate for the S&P 500 in Q1,which combines actual results with consensus estimates for companies that have yet to report, currently sits at -14.5%. 2020is setting up to be an ugly year for earnings, and the worst may still be ahead. For Q2 in particular, Glenmede estimates that profits for large-cap stocks in the U.S. could fall between 50% in our upside case and a whopping 90% in our downside case. In either case, our assumptions point to a recovery back toward normal levels in early-to-mid 2021.”