Two days after its 11th birthday, one of the longest bull markets in history ended. Over the last couple of weeks, the market experienced the fastest 20+% correction in its history. The fear of a global pandemic and crash of the oil market provided the one-two punch necessary to jilt a robust economy. Through the first couple of months of the year, the economy was in full expansion with high consumer confidence, low-interest rates, low energy prices, good business investment spending, and low unemployment, among other things.
Without minimizing the tragedy associated with the loss of human life, the fear of the COVID-19 is likely worse than the facts tell us it should be. The current economic data does not support the market correction we are witnessing. However, fear is creating reality. We believe the policy of social distancing will bring the US economy to the verge of a recession as characterized by a negative GDP for two quarters. If a recession occurs, the severity of it will depend entirely on how long it takes to get the virus under control and restore the confidence for people to return to normal society. The market is pricing in the above uncertainty. If the uncertainty is quickly erased, the economy and market should experience a relatively quick recovery.
In 2007, the media told us that high oil prices would cause a recession. In 2020, the media is telling us that low oil prices will cause a recession. So, which is it? In general, low energy prices are a tailwind to the economy. The demand for oil is relatively static regardless of price. Therefore, low oil (and corresponding gas prices) give consumers more discretionary income to fuel the economy. The risk of low oil prices lies primarily with the US-based drillers and the financial markets. In order to be profitable, US drillers need oil in the low $40s. The fear is that if it stays below profitable for too long, these drillers will default on their loans. This could cause issues with the financial institutions that financed these companies. Much like the 2008 housing crisis, this could cause liquidity issues in the credit markets, and credit led recessions are usually the most severe.
We are closely monitoring both events as they develop. At the moment, we believe the COVID-19 outbreak will be contained quickly. Although some damage to the economy has already begun, it appears that the market has priced that in. We expect a V-shaped market recovery although it may take 12 months or more to get back to the February 2020 high. We also expect Saudi Arabia and Russia to end their price war in the short, to intermediate, future. Much like when oil crashed in December of 2014, we expect the drillers to cap their wells to reduce operating costs as they buckle in for survival mode. In addition, the exposure of oil loans to financial institutions is not nearly as large as the housing market exposure was. We believe that a widespread threat to the financial markets is still a minor risk.
Fear (false evidence appearing real) is a strong emotion that is best erased with facts and analysis. Although we can’t control the economic fallout of COVID-19 or the oil markets, we are committed to providing a deeper analysis of the economic and portfolio impact to dispel the fear that leads to short term decision making. Please continue to monitor email and connect with MBM Wealth Consultants on social media. In addition, pass this onto your friends and family so that as many people as possible can benefit.