Last week will go down as the most dramatic and violent in the history of financial markets. Maybe there have been bigger percentage falls in the prices of assorted assets in the past but what we experienced over the last five trading sessions was unprecedented, unimaginable and brutal. This is true even though there was a massive rally late Friday both in the stock and oil markets. Given the gravity of the situation, however, this jump was based much more on hope and pre-weekend short-covering than a change for the better in the underlying global health crisis. Events over the weekend showed that the situation actually deteriorated. If God ruled the world as a business, he would shut shop and hang the “Closed Indefinitely” sign on the front door.
This seems to be literally the case. After Italy went into lockdown Spain and other countries followed suit over the weekend. In the UK mass gatherings are planned to be banned. Borders are closed, travel bans and mandatory quarantines are imposed, schools, restaurants and museums are shut and sporting events are cancelled or postponed across the world. The financial meltdown of last week was not even panicky; it came out of genuine and real fear of insurmountable social and therefore economic damage the current pandemic can cause.
The devastating impact of the coronavirus had been laid bare well before last week and recent events did nothing to calm nerves. When analyst, academics and lecturers look back at how exactly events unfolded they will be eager to point to the importance of not just the actions but also the words of key decision or policy makers. On Monday the oil market tumbled after Saudi Arabia decided to flood it and brought equities down with it. Some kind of calm was restored on Tuesday but a day later all hell broke loose. The World Health Organization declared the virus outbreak pandemic and this triggered renewed weakness in risky assets. The same day President Trump banned all travel from the 26 Schengen countries (he now added the UK and Ireland to the list) and stock markets crashed further as he was addressing the nation. To make matters worse the European Central Bank swung into action on Thursday. It announced new stimulus measures which will come in the form of a bond-buying programme but decided not to cut interest rates. On top of disappointing financial markets its newly appointed president, Christine Lagarde said that it was not the bank’s job to keep eurozone bond yields aligned. The remark pushed investors further out of the door and at the same time alienated Italy as the country feels abandoned by the block it belongs to. One can imagine that the comment was immediately seized upon by the euro-sceptic far-right and it might have a profound impact on the future of the Union. As the UK is progressing towards leaving the EU this is the last thing the old Continent needed.
Asian stock market tumbled early Friday and several central banks decided to introduce monetary easing. President Trump was on the move again on Friday evening. In two weeks he went from accusing the virus being a Democrat hoax that would go away to declaring national emergency. He freed up $50 billion to tackle the coronavirus epidemic. His style of managing the crisis is nothing but the usual ego trip. The consequences, however, could be more severe than before. With some smart campaigning from the Democrats he might have just made a giant leap towards not getting re-elected. Is the virus going the bring down the EU and Trump? It is possible. Anyway, US stock rallied almost 10% on the day but still finished the week 9-10% in the red.
Both equities and oil are falling once again this morning. Industrial output in China was down 13.5% in the January-February period, the biggest contraction for 30 years. Fixed asset investment fell 24.5%. These are awful figures. Central banks announced further cuts in interest rates on Sunday. The Federal Reserve reduced its target rate by 100 basis points to 0-0.25% and promised a fresh bout of bond-buying of at least $700 billion the near future. These steps, however, have failed to reach the desired effect. Stock markets are weakening again. The MSCI Asia-Pacific index outside Japan crashed 4%, the Nikkei 225 index is down 2.5% and US stock futures are also falling significantly.
Two shocks to handle
We also learnt last week that oil demand will suffer, especially in the first half of this year. The consensus figure is -1.43 mbpd – 1.74 mbpd in 1Q and 1.12 mbpd in 2Q. Concentrating on 2Q the call on OPEC has been cut by 1.22 mbpd on the month. It will look optimistic in a few weeks’ time. Add to that the Saudis launched a market share war against Russia and you might conclude that Goldman Sachs’ estimate of a global stock build in the region of 6 mbpd in April is not an exaggeration. The maths adds up – 1.1 mbpd (it will go higher) demand downward revision coupled with 4-4.5 mbpd extra supply as the OPEC+ alliance has fallen apart.
The following quote was taken from the OPEC Statute. “The Organization shall devise ways and means of ensuring the stabilization of prices in international oil markets with a view to eliminating harmful and unnecessary fluctuations.” It is open for debate whether the Russian and the consequent Saudi decisions to stop managing the market was something inevitable after a three year partnership or it was a clash of personalities but one thing became clear last week – OPEC, at least for the time being, has become dysfunctional.
Falling oil prices are badly hurting higher cos oil producers including US shale companies. The impact of it is perfectly reflected in the WTI/Brent spread and in the thinking of money managers. US producers are introducing spending and dividend cuts. US crude oil production and exports are expected to fall in the region of 1 mbpd in the near future. President Trump, when declaring national emergency on Friday, also announced additional SPR purchases to take advantage of the low oil prices. It is, therefore, not surprising that a.) oil also rallied after the settlement on Friday and b.) the WTI/Brent spread has strengthened from -$6/bbl a month ago to -$2 towards the end of last week. It is not a far-fetched thought the expect the US benchmark trade at a premium over Brent in the near future.
The latest CFTC and ICE reports on the commitment of money managers show that investors are less downbeat on WTI than Brent. They increased their exposure by 8 million bbls despite the more than $14/bbl drop in price. In Brent, however, net speculative length has been cut by 74 million bbls last week. It is an unprecedented discrepancy. The amount of money invested in WTI and Brent combined is $10 billion, down $7 billion on the week but still some $3 billion above the lowest point recorded in January 2016 when Brent fell below $30/bbl.
Despite Friday’s rally WTI settled at $9.55/bbl lower on the week whilst Brent fell $11.42/bbl. In one of our notes last week we said that if we were forced to provide a prediction, we would expect oil to break below the $30/bbl level. Given the resilience of COVID-19 and the stubbornness of Russia and Saudi Arabia to give concessions such a move is likely to happen. It could actually get worse. There is nothing more satisfying for an analyst or researcher than being correct. When we say that, under the current circumstances, oil could fall even below $20/bbl and stock markets could easily shed another 30-40% of their values we honestly hope that we will be proved to be wrong.