The sharp oil price downturn we are now seeing resembles the oil price slide of late 2015 and early 2016, which created turmoil in stock markets and especially in the corporate bond market – the latter because a sizeable proportion of that market consisted of American oil producers with increased credit risk.
The current oil price decline and ongoing steps to limit the spread of the virus increase the risk of a sharp economic slowdown or recession. This situation is triggering a decline in share prices, which is nothing strange. In the final months of 2018 recession worries also loomed, and stock markets lost nearly 20% − about as much as this time around (so far) – and then recovered relatively fast when worries faded and countermeasures were put in place, especially by central banks.
Continued stock market volatility
So what will happen now? No one knows how far the virus will spread, for how long and how the major steps being taken to curb its spread will hamper economic growth. Nor does anyone know what will happen to oil prices and how the parties to the current disagreement will act. But we can assume that market turmoil will persist for a while and that it will take time before it becomes clearer how the virus is spreading and which way oil prices will move. There is consequently an obvious risk of continued stock market volatility, and perhaps new downturns.
Looking a bit further ahead, however, there is reason for cautious optimism. It is important to remember that all the measures (key interest rate cuts, economic stimulus) now being put in place to ease the impact of the virus epidemic will enable the affected economies to grow more vigorously once today’s worries have faded. This may actually create better growth and corporate earnings potential than before the COVID-19 outbreak.
But first, the remaining issues will probably need to be resolved. As for oil prices, none of the producer countries involved in the current dispute over production levels has anything to gain from continued low oil prices. Meanwhile low oil prices have some positive growth effects, via lower energy costs.
Our conclusion is thus that in the short term we must take into account an oil price decline like the one we are now seeing, but we believe it will have a limited effect a bit further ahead.
Impact of the virus epidemic
What will be the impact of the virus epidemic? Based on earlier experience, especially from China in recent weeks, the global spread of the virus may culminate about one month from now. Does this mean everything will revert to normal? Well, perhaps. If the rest of the world can relatively quickly follow the example of China, which is now beginning to re-open cities and factories, this probably means that the global economy will recover and that the effects of the virus on production and demand will “only” be a dip in the growth curve. One or two quarters of deceleration may very well be followed by an acceleration, driven by the need to “recoup” lost production and consumption − fuelled by lower interest rates and by government stimulus measures. In such a scenario, stock market indices will probably be well above today’s levels one quarter from now, and in that case we are approaching a buying opportunity.
Economic and stock market trends
However, there is a major risk that the impact of the epidemic will be more serious and long-lasting. Steps to limit the spread of the virus may have long-term effects on the economy, for example by forcing businesses to lay off employees, which in turn would decrease potential consumption and demand.
In that scenario, the slump would last longer, and the recession that many observers are worried about could become a reality. In that case, of course, there would be plenty of room for new stock market downturns. But how deep could they conceivably be? That depends on how deep and long-lasting the economic slump would be. Today we are seeing few indications that such a downturn would necessarily be as deep as the 2008-2009 recession, when stock markets fell by roughly 50% and took several years to recover from their downturn. If we instead experience a more “normal” economic slowdown, it would be more reasonable to expect stock markets to fall by 20-30 per cent, with share prices rebounding within a year or so. This would mean that further stock market downturns are in the cards – but also that we have already seen most of the overall downturn.
Markets are likely to remain volatile for another while. We will probably experience tough new stock market days, as well as new reports of a spreading coronavirus. But if earlier experience is any guide − and given the fact that stock markets have already declined sharply − there are still many indications that investors who are in it for the long haul will be rewarded for waiting out the current market turmoil.
We are naturally prepared to reduce the risk level in the portfolios we manage if the market picture worsens further. But at present − because of the already large downturns − we consider it more likely that we are approaching a buying opportunity, even though today’s market turmoil calls for short-term caution.