Asset owners take hit as oil price war escalates

Investment markets globally have plummeted as Russia and Saudi Arabia prepare for a lengthy oil price war, leaving asset owners on their toes about their investment portfolios and their respective asset allocations.

The hardest hit markets have unsurprisingly been the Italian stock market, which is almost 30% off its peak, and oil, which has fallen over 40% since its peak, but government bond yields have also moved dramatically – the 10-year UK gilt almost yields zero.

Tine Choi Danielsen, chief strategist at PFA in Denmark, said: “The fall in oil prices, in the short run, increases the risk of a negative spiral that could end in a self-fulfilling crisis.”

The energy sector represents 14% of the US high-yield bond market, compared to 3% of the S&P500. “As oil revenues fall, the risk of debt defaulting increases, and this is the fear that is causing investors to sell off risky assets today,” he said.

“Back in 2014-2016, we pulled through, but as opposed to then, today there is now downward pressure on both the demand and supply side for oil producers, which has led several oil analysts to warn of declines down to $20 a barrel of oil,” he added.

Marija Veitmane, multi asset class research senior strategist at State Street Global Markets, believes the European economy is already in a weak state, having suffered from the US/China trade war in the last couple of years, as stock analysts increasingly downgraded the earnings outlook for European companies.

“With this in mind, investors would do well to consider being underweight European stocks relative to the US and emerging markets,” she advised.

Kerrin Rosenberg, UK chief executive officer at Cardano, thinks otherwise.

“During market turbulence such as this, it is often not possible – and may be unwise – to try to make significant changes to your portfolio. The best protection, as ever, is to have been prepared before the panic.”

He added: “It is impossible to predict how much further markets could move, but we should remember that this rout comes after a very strong decade of stock market returns, with most markets looking relatively expensive on historic metrics before the crisis erupted.”

Coronavirus panic

Rosenberg said that as investors begin to realise the potentially severe impact from the coronavirus outbreak, markets are “reacting violently”.

“There are signs of panic and some of the movements we are seeing day-to-day are reminiscent of 2008,” he noted.

Chris Towner, director at Chatham Financial, concurred, adding that “the coronavirus is spreading globally and with it, economic fears are spreading also. Fear often comes from dealing with the unknown and it is the unknown scale of the impact of the virus that is putting pressure on the financial markets.”

He said that comparisons are already being made to the financial crisis of 2008, but this particular ‘crisis’ has hit oil as well as share prices and “the real question is how much more of a negative impact can this virus have and for how much longer?”

Fiscal stimulus

Attractive interest rates of 2.25-2.5% in the first half of 2019 have now been replaced with rates of 1% and expectations of further 50 to 75bps of cuts. This would bring US rates back down to where they were at the start of the cycle – their historical lows, he said.

This can be compared with the European Central Bank (ECB), which has practically no more room to cut rates from its current level of -0.50%.

“Rates in the euro area have been at these emergency levels for a long time, now forcing the ECB to push back at EU leaders to start stimulating their economies. The coronavirus has been the obvious catalyst for this debate; however, it arguably is too little, too late,” Towner said.

Veitmane said that while interest rate cuts can do little to combat the potentially immediate economic shock of the virus, “it will ease the cost of working capital for businesses if demand falters or supply chains lengthen”.

“Unfortunately, Europe has the least amount of monetary and fiscal space to support markets, unlike China and the US who are leading policy stimuli,” she said.

Towner added: “A significant jump in the number of new infections will lead to further volatility, whereas the first signs of containment should give markets a welcome bounce. One thing for certain is that until the outlook becomes clearer, volatility is here to stay.”