We mentioned last week that investors had successfully managed their expectations and drastically reduced earnings-per-share and growth forecasts. In light of indications that lockdowns were being relaxed, markets were relatively buoyant.
This week, the news flow has poured cold water on these green shoots. The gravity of the situation was reiterated as Japan declared a national emergency, ‘rest in place’ orders were extended across major US cities and European countries until the middle of May and corporate earnings continued to sound a negative tone.
Are investors becoming more rational, or just jaded?
Over the past month, it has become clear how the lockdowns in place have heightened uncertainty. Companies have acknowledged the negative impact on Q1 earnings, but what is remarkable is their inability to provide any guidance. Recently, an American employment agency stated that “As we cannot forecast when governments in certain major markets will be lifting current work restrictions, we will not be providing guidance for our second quarter earnings."
Markets abhor uncertainty, which is usually indicated by a spike in the volatility index (see figure 1). Remarkably, volatility is well down from its peak at the end of March. Perhaps, investors are tired after a month of turmoil in markets. Caution is needed, however: another steep plunge in the oil price could trigger a surge in this measure of fear.
Figure 1. The VIX is down from its peak
Source: Bloomberg, as at April 2020.
Oil slides into negative territory
We argued last week that while the Oil for Petroleum Exporting Companies and Russia had agreed the largest production cut in history, this was unlikely to conjure up demand that was simply not there (and will not be there until economic activity rebounds).
Over the past week, the price of West Texas Intermediate crude oil for June delivery plunged by over 43% to $11.57 a barrel – the lowest level in 21 years, and the largest intra-day drop since 1981. Brent crude, the international benchmark, fell less, but was still trading below $20 a barrel. As markets realised that the oil-supply glut looked set to continue, oil-price volatility jumped to over 400%.
Meanwhile, the contract for delivery in May – which expired earlier this week – declined to almost -$40 a barrel as producers paid buyers to take oil off their hands (see figure 2).
Figure 1. WTI takes a tumble
Source: Bloomberg, as at April 2020.
This is down to storage limits, which forced oil to move into the extremely rare state of ‘mega contango’. In this situation, near-term spot prices are lower than that of oil for delivery in the future – a reflection of the lack of demand for oil in the short term, as transport infrastructure remains frozen.
Our Multi-Asset team notes that this is the key difference between a futures market – such as the one for oil – and the stock market, which attempts to forecast the future by discounting cash flows. The futures market, on the other hand, simply reflects a snapshot in time.
Central banks pull out the stops
We continue to face a catalogue of knock-on effects from the coronavirus pandemic, including travel bans, a halt in immigration in the US, retail bankruptcies and soaring unemployment. In the face of this, central banks and governments have stepped up in an attempt to plug some of the shortfalls caused by their policies.
In the US, a second wave of small-business loans and a package worth over $450bn have been proposed – and will likely be passed. Meanwhile, other nations such as the UK have focused on making sure aid is where it is needed. These US commitments are a possible explanation for why American markets have outperformed their European counterparts year-to-date.
Emerging markets: will they weather the storm?
Our Global Emerging Markets team uses a vulnerability matrix to distinguish between countries. It considers Malaysia, Turkey and South Africa to be the most vulnerable, as they have low import cover and a high share of external debt. On the other hand, energy importers like India and Indonesia will benefit from a lower oil price.
Overall, the team thinks that emerging markets are less vulnerable than they were in 2008. However, all countries in the benchmark have been affected by a slowdown in manufacturing, cratering oil prices and depressed demand, while threats to growth have imperilled countries like India and Brazil.
Nonetheless, the team remains focused on long-term structural growth trends like an aspiring and growing middle class, increasing digitisation and development led by governments through productivity-boosting reforms and infrastructure projects. Moreover, valuations are attractive at the moment and we believe the current crisis offers an opportunity to buy quality companies at discounted prices.