Market Volatility – March 2020
Since writing to you late last month we have seen continued volatility in financial markets, culminating in substantial drops in equity markets over the last few days. The steep falls have been caused by a combination of the coronavirus and reduced oil prices as a result of oversupply vs lower demand. There has also been a price war that has broken out amongst major players, Saudi Arabia and Russia.
While oil price shocks have a potential to rock markets and frequently have in the past, the latest development comes at a time of already high fragility for markets. The backdrop to the volatility, as we all are now all aware, is the uncertainty and disruption caused by the onset of the highly contagious new virus (now widely known as coronavirus COVID-19), which has taken hold in a number of countries.
The below chart highlights the number of cases identified in China and the remainder of the world from 22/1/2020.
What is the ‘oil crisis’ and why has it caused further market falls?
The catalyst for the steep falls early this week both domestically, and across international markets was that oil prices suffered a historic collapse after Saudi Arabia shocked the market by launching a price war against onetime ally Russia. The turmoil comes after the implosion of an alliance between OPEC and Russia, which had been restraining oil supply since the start of 2017 in an attempt to support prices.
In short, Russia refused to go along with OPEC’s proposal to rescue the coronavirus-battered oil market by further cutting production at a meeting in Vienna on Friday. The standoff left the oil industry shell-shocked and sparked a 10% plunge in oil prices Friday. Crude oil was already reducing because of a sharp drop in demand linked to the coronavirus outbreak.
Saudi Arabia escalated the situation further over the weekend. The kingdom slashed its April official selling prices by $6 to $8, according to analysts, in a bid to retake market share and heap pressure on Russia. US oil prices have since crashed as much as 34% to a four-year low of $27.34 a barrel as traders brace for Saudi Arabia to flood the market with crude in a bid to recapture market share.
There is also the risk of credit exposure to the oil sector could result in further write-offs if oversupply issues continue to keep a lid on oil prices. Our view is that lower demand will persist for years, thanks to the weakening outlook for China and Europe, while supply has been expanded by booming US shale production and stubbornly high Opec production.
Is the world headed for a recession?
Whilst the very term ‘recession’ invokes very negative feelings, one should remind ourselves this is simply a technical term economists use to describe two or more consecutive quarters of negative growth. The short answer is that, at the moment it is a complicated situation where no one really knows how far and deep the virus will spread and just how bad the disruption to the global economy will be, or how long it will last.
Therefore there needs to be a period for the market to resolve a lot of uncertainties that have emerged since we have learned more about the virus and its spread and the tendency for world media outlets is more alarmist that realist, increasing the risk the world ‘scares itself into recession’. The economic impact from developments already known (supply chain delays caused by factory shutdowns, lockdowns of major cities in China and abroad, the global halt of non-essential travel and impact on airlines and tourism, decline of retail spending across Asia) are very real and will dent economic growth this year and has increased likelihood of a recession.
Having said that there is an expectation for a coordinated Central Bank response, which may or may not be enough, depending on how much is thrown at it, and how long it takes for virus fears to dissipate.
It is important to note that with recent falls, uncertainty has caused markets to ‘price in a recession’ until it knows more. This situation creates opportunities for long-term investors who can see through the noise and focus on the relationship between Price and Value because ultimately, once uncertainties are resolved the market will reflect earnings and potential for growth in earnings.
Should I buy, hold, or sell?
There is no doubt Coronavirus represents major problems to overcome for the global economy, and the market reaction has been severe. What really matters however, is whether recent price changes is proportional to the worsening of fundamentals.
For clients who are already invested and have a long-term horizon, we recommend to hold as such market corrections are already accounted for when setting your long-term strategy, as risk rewards long-term investors. We also remind investors that the cost of selling and buying in volatile markets means you will likely be behind compared to if you just held.
The chart below shows that since 1993 the ASX300 has provided a total return of 9.8%pa, whilst a common timing strategy (to sell after a 10% fall in the share market, and to buy back in after things calm down and rise 10%. ) would have returned 8.3%pa and a whopping 32% less wealth whilst buying and selling 18 times. Change that to a ‘down 5% sell, up 5% buy’ strategy and you would have received a 4.14%pa return and 76% less wealth, buying and selling 74 times (chart and analysis provided by Ophir Asset Management).
What lessons can we learn from the past?
In 2008, shortly after Lehman’s Brothers collapse an in the darkest hours of the financial crisis, Warren Buffet published an article entitled ‘Buy American. I am’. In the article, Warren started with describing the list of seemingly insurmountable problems for the US economy including unemployment, faltering business activity and white-knuckle headlines. He also described how he had been buying stocks.
This is not about how he timed the market recovery to perfection but rather about how he did not – stocks continued to fall another 26% before the start of the next Bull market six months later. However, the market is still up 227% since that article was published up to last Friday.
We continue to monitor the ongoing market conditions as part of our wider operations. If you have any questions about your investments or the path that lays ahead, please get in contact with an advisor here at Endorphin Wealth.