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Oil prices dropped more than 20% Monday (March 9) following a breakdown in OPEC production talks over the weekend, adding to the coronavirus anxiety in the markets. Equities were down sharply Monday, extending the pullback that began in mid-February, with the rush into lower-risk investments (Treasury bonds, gold) pushing interest rates to all-time lows.
Oil and virus containment measures pose credible headwinds that will impact near-term growth, but in our view, markets are trading much more on fear and emotion at the moment (as they tend to do periodically), which raises the importance for investors to take a more rational, disciplined approach. Markets may feel like a roller coaster, but ups and downs are likely to continue a while longer as the situation evolves. Remember, history and experience have shown us keeping your eyes on the horizon are generally more effective than trying to exit mid-ride. Here are a few points to consider about the latest market moves:
The latest wrinkle in the stock market correction has come from the oil market, with crude prices experiencing their largest drop in nearly 30 years, With Russia failing to agree to proposed OPEC production cuts (reducing supply to support prices), Saudi Arabia announced retaliatory price cuts and production increases which poses significant challenges for other global producers, including the U.S.
Monday's historic drop in oil prices threatens investment, employment and financial stability in the energy industry, which is adding to the virus-related uncertainties for the Canadian economy. This is further weighing on stock prices, with the TSX and the S&P 500 off more than 16% from the mid-February highs.1 In turn, stock market worries are prompting significant demand for lower-risk Government of Canada bonds, pushing the 10-year rate to an all-time low below 0.50%.
The sight of 10-year yields at these levels is adding to the feedback loop of higher volatility driving lower stock prices, which drives lower rates, which then drives higher volatility.
Investors can take comfort in the fact that:
a) These types of episodes don’t as a rule last indefinitely, and
b) The fundamental underpinnings of the economy are not declining in a manner or rate that stock price and interest rate movements seem to suggest.
We think the economy will take a meaningful hit in the near term. Efforts to contain the spread of the coronavirus -- such as adjusted work schedules, school closings, delayed business investments and altered consumer spending habits – are likely to produce a temporary contraction in GDP. Given energy's sizable contribution to the Canadian economy and the increased role of energy production in the U.S. economy in recent years, the news of a budding oil price war will add to the near-term headwinds as investment and employment in the energy industry are impacted.
However, some of these factors have beneficial effects as well. First, the economy entered this situation with a clean bill of health. Labour market conditions were the best in decades, housing activity was on the rise, and financial conditions for consumers and businesses were favourable. The recent plunge in interest rates has positive implications for consumer and business financing costs as well as housing conditions. Refinance activity has surged, which will help put more money in consumers’ pockets.
The drop in oil prices offers another boost to consumers' disposable income via lower prices at the pump, as well as lowering some input costs that can help keep inflation low. To that end, the Bank of Canada and the U.S. Federal Reserve have responded with rate cuts and are likely to lower rates even further from here. While none of these will halt the virus impacts in the coming weeks, we believe they do set the stage for the economy to rebound smartly as the temporary effects of the coronavirus pass.
This pullback shouldn't be dismissed, but times like these require perspective:
In our view, diversification and a long-term approach show their greatest value in times like these. Balanced portfolios are not mirroring the daily swings in the stock market.ᵌ While the headlines and the market seem to be changing rapidly, your financial goals likely aren’t. Ensure your goals are the guide as you make decisions. Times of fear and volatility in the markets have historically presented opportunities for investors who leverage the advantage of time and a longer-term perspective.
1 As of Monday morning, March 9.
2 Past performance is not an indication of what will happen in the future.
3 Diversification does not ensure a profit or protect against a loss in declining markets.