Stocks and Oil Slide Into US Thanksgiving
October weakness continued through to Thanksgiving in the United States. The S&P 500, MSCI World and TSX fell 2.4%, 2.1% and 0.9%, respectively, during the first few weeks of November. The large market cap names who piloted the rally were also the drivers on the downside; Apple (-19.2%), Netflix (-17.9%), Amazon (- 15.4%) and Facebook (-12.2%). Digging deeper into the eleven sectors of the S&P 500, only Health Care (+0.8%), Materials (+2.5%), Real Estate (2.8%) and Utilities (0.2%) were positive.
It seems that Emerging Market equities may have turned a corner despite the challenges in global developed equity markets. During November, iShares MSCI Emerging Markets Index ETF (EEM) gained 0.8% despite the heavy weighting in Technology. Elsewhere, gold and US Treasuries both exhibited strength, with bullion rising 0.6% and US 10-year yield dropping 8bps to 3.06%, marking two consecutive months of strength following the 3.20% 5-Oct 2018 peak in yield. Despite gold’s performance, most commodities were down. The slowing global growth narrative was stoked by dim hard data measures such as the Purchasing Managers’ Index and Durable Goods purchases.
Fears of slowing global growth spilled over into oil markets as WTI followed a 12% drop in October with an 18% plunge. There have been no shortages of headlines to justify the decline.
- President Trump’s support for Saudi Arabia has reduced anxiety in the Middle East.
- OPEC’s ability and/or willingness to cut production has diminished.
- Forced liquidation of long oil/short natural gas positions by large investment funds.
We remarked in past commentaries that most investors seemed to be on the bullish side of the oil trade. Certainly, timing a reversal is rarely successful, but recognizing the risk of a shift helps protect wealth over time. Sentiment was such that any of the above headlines could have caused a setback for oil, while few upside surprises remained.
Fundamentally, it is interesting to observe the chart of oil consumption vs. production from 1970 to 2017, and contrast it with global growth’s impact on overall demand for oil. Despite almost 50 years and six recessions, consumption of oil has been fairly consistent – only the 1973-75 OPEC production cut-driven recession had a material impact. We understand the potential long-term impact of alternative energy and electric vehicles, but in the near term, we still anticipate consistent demand being met by production that runs slightly below the consumption line. As the chart on the left demonstrates, there would have been an oil shortfall without the ramp in US production originating in 2008. Most of the advancement in US oil production has come from shale. Any hiccup with extraction of shale oil could become a catalyst for a sharp price move to the upside. Further, there are unappreciated cost-sensitivities in the shale industry. The highly indebted sector is beginning to experience a rising interest rate environment; and, the land in the Permian has appreciated from $2,000 per acre in the early 2000s to $95,000 per acre in November 2018.
Speaking of indebtedness, the market has finally acknowledged the massive corporate debt load that escalated thanks to easy borrowing terms and an unquenchable thirst from investors. Without an extension in the unprecedented low interest rate environment or the cash flow to pay off existing balance sheet debt, companies such as General Electric, Ford Motor Company, or Anheuser Busch have become candidates for downgrades. Current interest rate coverage ratios support stability and the economy remains strong but rising borrowing costs or a slowdown in business can quickly become problematic for over-levered organizations.