Pennsylvania Trust

OPEC/Russia Feud Adds Angst to Already Fragile Market

OPEC/Russia Feud Adds Angst to Already Fragile Market

Major equity indices experienced their worst single session since the 2008 financial crisis as a full-scale oil price war rattled financial markets already on edge over the spreading coronavirus. The S&P 500 was off 7.5%, the ten year Treasury yield declined to 0.55% (prices higher) while crude fell roughly 25%.

There is now an increased expectation that the U.S. Federal Reserve will provide further stimulus via another rate cut (and potentially asset purchasing) as central bankers do all they can to keep the coronavirus from spurring a more pronounced economic slump. In addition, the Trump administration is reportedly working on a fiscal stimulus package to help lessen the effect the virus is having on the economy.

A 20% correction is often referred to as the emergence of a bear market. While this may occur, it’s important to note that economic and equity fundamentals were sound prior to the emergence of coronavirus coupled with the unexpected collapse of the OPEC+ coalition led by Saudi Arabia and Russia. As a result, we believe the disruption should ultimately prove to be transitory and believe that we will look back at this as a cyclical correction (maybe bear market) within a long-term secular bull market.

As we have pointed out on pages 10 and 11 in our Economic Insights, stocks are inexpensive when compared to bonds, hence the recent volatility will eventually produce new opportunity. In addition, lower oil prices and lower interest rates should be supportive for the consumer in due time.

The Source of the Angst

The sell-off in oil revolves around OPEC failing to strike a deal with its allies, led by Russia, about oil production cuts. That breakup of the OPEC+ Alliance, in turn caused Saudi Arabia to cut its oil prices and announce a 2.5 million barrel per day increase in supply. When combined with the temporary demand hit from coronavirus’s effect on global growth, prices declined by the second-most on record.

Many investors now worry that the falling price of oil will hurt the economy more now than it has in prior years when lower oil prices were often viewed as an economic stimulus. While consumers may enjoy the savings related to filling cars and heating houses, the oil industry will likely see increased bankruptcies, loan defaults, job losses, and a disruption in capital spending.

Today’s market selloff was predicated on what this disruption may do to the overall economy.  Ultimately, while oil and gas extraction, pipeline operation, refining, along with support companies account for roughly 540,000 jobs, the industry now supports an estimated 10 million full-time and part-time jobs, which accounts for over 5% of total US employment (according to a study commissioned by the American Petroleum Institute and conducted by PwC LLP). The chart below details how the industry supports each state.

Disclosure: This Commentary represents a review of topics of possible interest to Pennsylvania Trust’s clients and is not personalized investment advice. It contains Pennsylvania Trust’s opinions, which may change following the date of publication. Information obtained from third-party sources is assumed to be reliable but is not guaranteed. No outcome — including performance — is guaranteed, due to various uncertainties and risks. This document is not a recommendation of any particular investment. Investment decisions for clients are made on an individualized basis and may be different from what is expressed here. Past performance is no guarantee of future results.