Bull Cases in Trouble Everywhere as Oil Adds to Stock Stress
(Bloomberg) -- Fund managers broadsided by the tumble in megacap tech stocks have a new reason to stress out: oil’s epic losing streak.
West Texas Intermediate futures have fallen a record 12 sessions, including Tuesday’s 7 percent tumble, leaving them down nearly 30 percent from early October to hit $55.69 a barrel at yesterday’s close. Energy stocks were the biggest drag on the S&P 500 Index on Tuesday as the benchmark gauge reversed a gain of more than 1 percent to finish in the red. Crude looks set to pare some of this damage on Wednesday, with futures pushing above $56 a barrel as of 8:22 a.m. in New York.
Just as is the case for risk assets broadly, fear is triumphing over seemingly firm economic fundamentals in crude. In the already tattered equity market, memories of 2015 and 2016 are bubbling up as analysts debate whether the plunge is an isolated reaction to rising supplies or something more ominous.
“We have a little bit of a nervous market right now and I agree that the reaction may be a little bit strong given the change in fundamentals, which aren’t huge,” Marc Pinto, portfolio manager at Janus Capital, said on Bloomberg TV. “But it’s a skittish market and we’ve seen this in other sectors, especially cyclical sectors, where people have taken a little bit of bad news and gone a long way with it.”
It’s tough to blame stock traders for feeling queasy about the signals sent by the cratering commodity. Even though the magnitude of the drop pales in comparison to oil’s downdraft from mid-2014 through early 2016, it amplifies concerns about the future for U.S. earnings growth.
After all, oil’s last plunge precipitated a profit recession for the S&P 500 Index, with the trailing earnings per share for the energy sector falling more than 90 percent from peak to trough.
“As is often the case, the speed of the move is what creates problems for markets,” said Mayank Seksaria, chief macro strategist at Macro Risk Advisors. “In the near term, in an already elevated volatility environment, oil volatility (OVX) has jumped to over 50 -- this is going to exert some upward pressure on VIX and thus unlikely to help stabilize the S&P 500.”
It’s not like stocks were on especially firm footing to begin with. The S&P 500 is down more than 7 percent from its September record and the VIX -- the Cboe Volatility Index -- is back above 20 after spending most of April through September below it. Tech stocks are in a full-blown correction, with the Nasdaq 100 off almost 11 percent since August.
Though energy stocks have come under pressure recently, analysts haven’t been quick to factor in how the price drop will affect financial performance next year. Estimates for 2019 earnings growth are higher for energy companies than the S&P 500 as a whole, a reversal of what the sell-side had anticipated heading into 2016.
While oil’s travails may undercut the bullish view of the stock market, bears expecting a repeat of the 2015-16 experience may end up similarly disappointed. Energy’s ability to directly hurt U.S. equities -- and the economy -- is substantially lower than it was in mid-2014 at the height of the shale boom.
Energy’s share of the S&P 500 by market capitalization has been halved since mid-2014 to just 5.5 percent.
“The drop in oil prices is still good news for U.S. consumers while the decline is negative for mining investment,” said Neil Dutta, head of U.S. economics at Renaissance Macro Research. “The good news is that mining investment has been cut almost in half relative to GDP since 2014.”
Signs of stress are starting to appear in energy junk debt, though this segment has posted nearly flat returns this year. Yields have spiked more than 40 basis points over the past two sessions to their highest level in more than two years. Bloomberg Intelligence U.S. credit analyst Spencer Cutter had highlighted $55 per barrel as a level in which cracks might start to appear in these bonds.
A certain degree of survivorship bias is helping the group avoid an even worse fate: The weakest of this cohort were felled during the last negative shock that saw crude trade in the 20s, leaving behind peers better equipped to weather low prices.
At the periphery of arguments about oil’s economic impact are theories about how its decline might affect funds that derive some of their wealth from its proceeds. Sovereign wealth funds across the globe hold about $7 trillion in assets, according to the Sovereign Wealth Fund Institute data, and half of the biggest are in the Gulf Coast. Saudi Arabia’s needs oil at $70 per barrel in 2018 to break even, the International Monetary Fund said in October.
Bulls may yet find a silver lining to the drop in oil prices. Coupled with U.S. dollar strength, these dynamics may raise sufficient concerns about the state of the global economy and outlook for U.S. growth and inflation that they serve as a braking force on the Federal Reserve’s tightening cycle. For now, the New York Fed believes the decline in crude over the past weeks is a product of increased supply rather than diminished demand.
On Wednesday evening, Fed Chair Jerome Powell will have an opportunity to soothe scared investors in the most appropriate setting: the heart of oil country during a discussion with Dallas Fed President Robert Kaplan.
©2018 Bloomberg L.P.