Just as investors were trying to come to terms with the Coronavirus, Saudi Arabia decided to flood the market already depressed by the virus, with hundreds of thousands of barrels of additional oil per day. While this initial volatility is a price war between the Saudis and the Russians, U.S. shale producers are caught directly in the crosshairs. Oil prices plunged nearly 30% on the news, dragging down stocks around the world.
Investors are extrapolating that between the slower economic growth caused by the Coronavirus and falling oil prices that deflationary pressures will mount, possibly causing a recession. Last week the Fed cut interest rates half a percent (50 basis points) in response to the slowing economy caused by the virus. More cuts are likely around the corner, with increasing prospects of negative rates coming to the U.S. just like much of Europe and Asia. We also suspect that the U.S. government and others will announce some form of stimulus programs aimed at giving a boost to the ailing economy in the not too distant future. Over the past few years, America has greatly reduced its energy reliance on the Middle East as shale producers ramped up production. The price war between the Saudis and the Russians is likely aimed at forcing some of these domestic shale producers out of business so the Saudis and Russians can win back their influence over the world’s oil market.
Lastly, economic concerns make their way into the political arena. Earlier this year, we published a piece discussing the upcoming presidential election. History shows that the incumbent has the inside track except when the economy is struggling. A recessionary environment hurts President Trump’s re-election chances. As the Democratic field narrows, investors will likely be somewhat relieved as Biden appears to be pulling away from Sanders.
The best piece of wisdom we can provide is to think logically and not emotionally. We know this is much easier said than done. No one likes to see the value of their portfolios decrease. Days like this are ruled by emotion and computerized trading. There’s not much that can be done about that. Rather, we are using this as an opportunity to buy good companies at attractive prices.
It appears that the U.S. will soon be joining the rest of the world with negative interest rates. What does this mean? Buyers of bonds will essentially lock themselves into negative returns, and banks will charge customers a fee to hold their deposits. In such an environment, a high-quality stock paying a 3 or 4 percent dividend yield looks to be a compelling option. Obviously, stocks entail risk and are not a substitute for cash and equivalents. Still, in an environment of record-low interest rates, we believe that stocks can play an important role as part of a diversified portfolio.
During times of panic, investors tend to sell stocks indiscriminately, essentially “throwing the baby out with the bathwater.” Granted, some industries and companies will be negatively impacted by the virus scare. Airlines, cruise lines, hotel chains, casinos, etc. will all see negative impacts on their businesses. Declining oil prices will undoubtedly take a toll on energy-related companies. Other companies have seen their share prices suffer during this selloff that we believe should see minimal impact to their businesses. We have been, and continue to be, overweight the consumer staples, believing that they offer attractive valuations, stout dividends and business models that should not be negatively impacted by either the virus scares or declining oil prices. One could argue that for a good portion of the country (oil patch excluded, of course) that falling interest rates and fuel prices will provide consumers with additional funds.
We wish to close on a quote from Warren Buffett, “Where we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”