Investing

A Crude Awakening

The latest wild card couldn’t have come at a worse time.


Our Top Market Takeaways for the week ending March 09, 2020.

Another draw from a deck stacked with wild cards

Over the weekend, Russia and Saudi Arabia abandoned their agreement to curtail oil supply in an effort to support prices. Russia was tired of playing along with the Saudis, and refused to further cut production. In response, the Saudis dropped their official selling price for crude by the most in 20 years and signaled that they would likely ramp up production. Brent crude prices dropped from their Friday trading range of $45–$50 per barrel to ~$35 per barrel at time of writing. Brent prices are down almost 60% from their recent peak in September 2018.

The line chart shows the Brent crude USD per barrel from January 2018 through March 9, 2020. It shows that the sharpest decrease in this timeframe is occurring now.

The return to a fight for market share among oil producers is bad news for financial markets. The S&P 500 is down almost 6% after hitting the circuit breaker when the market opened. The Nikkei ended down 5%; Hong Kong’s Hang Seng dropped 4.2%, and European markets are down anywhere from 5.5% (Switzerland) to 11% (Italy). U.S. 10-year Treasury yields are trading below 50 basis points (bps) for the first time ever. The market is pricing that the Fed will cut interest rates to zero by the middle of the year.

The breakdown of the OPEC+ agreement is another wild card that is being played at exactly the wrong time for financial markets and the economy. The situation is extremely fluid, but this is our initial sense for how the move in oil prices will interact with COVID-19 in the coming weeks, months and quarters. Bottom line: The move in oil prices is a clear negative for financial markets, and spillover from financial market pain to real economy weakness is becoming more and more likely.

Bottom line: The move in oil prices is a clear negative for financial markets, and spillover from financial market pain to real economy weakness is becoming more and more likely.

Consumer: All else equal, lower oil prices are a positive for U.S. consumers. Indeed, last year U.S. consumers spent around $350 billion on gasoline and other fuel oils, so any reduction in price helps keep more money in the average American’s checking account. The problem is, that only represents less than 2.5% of total personal consumption expenditures (down from ~4% during the halcyon days when Brent was trading above $110 per barrel). For consumers, this reduction in oil prices is very similar to the reduction in consumer borrowing costs from the decline in interest rates. Yes, it is a positive, but it seems like a much more powerful force (uncertainty in the face of COVID-19) is likely to stifle demand. The silver lining is that the consumer balance sheets are still very healthy, and a reduction in consumer-facing interest and energy costs helps maintain that position. But it would be overly optimistic to expect a spending surge on the back of these reduced costs.

Rates: Rates are very unlikely to rise materially anytime soon. Thirty-year Treasury yields are below 1%, 10-year Treasuries are below 50 bps, and 2-year yields are at 30 bps. And globally, some 25% of investment grade bonds are yielding less than zero. Why does oil matter to rates, anyway? It all goes back to inflation expectations. Gas prices are one of the prices that factors most prominently in consumers’ minds. Because of this, it has an outsized effect on inflation expectations, and inflation markets (think things like TIPS) are priced off of headline CPI. As the price of oil declines, inflation breakevens (which do enter into the Fed’s calculus) decline as well. Inflation is even less of a threat, and investors have a reason to pay high prices for the relative safety that Treasuries provide. Right now, the market expects the Fed funds rate to be back at zero by July.

The line chart shows the Fed funds target rate from 2015 through March 3, 2020. It also shows future market expectations for the Fed funds rate to go back to 0%.

The line chart shows the Fed funds target rate from 2015 through March 3, 2020. It also shows future market expectations for the Fed funds rate to go back to 0%. 

Unemployment and investment: The shale revolution altered the United States’s relationship with oil prices forever. However, there may be less employment exposure to oil and gas employment than meets the eye. There are 90,000 Americans currently employed in non-supervisory oil and gas extraction roles, down from the 2015 peak of 110,000. When crude prices fell 60% from May 2015 to early 2016, oil and gas employment fell by a third to just over 70,000. Given the 50%+ drop in crude prices from 2019 peaks, it seems reasonable to assume that jobs are at risk in the oil and gas extraction sector again. But even when you assume spillover into related sectors (oil and gas services, etc.), the numbers are relatively small when you consider there are over 105 million private non-supervisory employees on payrolls. Indeed, the oil shock of 2015 and 2016 is almost imperceptible on the overall unemployment rate. Likewise, energy CAPEX as a % of GDP is already relatively low, so the energy shock alone seems more important for financial markets than for energy CAPEX and GDP as a whole.

The line chart shows the number of production and non-supervisory employees by the thousands from 1980 through January 2020. It shows that the number has been increasing since 2016.

The line chart shows the number of production and non-supervisory employees by the thousands from 1980 through January 2020. It shows that the number has been increasing since 2016. 

Distressed assets: The energy sector broadly was getting punished by markets even before this weekend. Energy is the largest weight in the high yield bond index, and low prices are clearly a negative. Energy high yield spreads have been widening since early 2019, and overall spreads are starting to follow. Given the recent decline in oil prices, it wouldn’t be surprising to see spreads near the levels we saw in early 2016, and to see defaults in the energy and energy-adjacent sectors pick up. This could present some tactical opportunities, but we believe the water is still too cold; it’s adult swim only.

The line chart shows two lines from 2010 through March 6, 2020: one showing energy high yield spreads and one showing spreads overall. It shows that energy high yield spreads have been widening since early 2019, and overall spreads are starting to follow.

The line chart shows two lines from 2010 through March 6, 2020: one showing energy high yield spreads and one showing spreads overall. It shows that energy high yield spreads have been widening since early 2019, and overall spreads are starting to follow. 

Earnings: The energy sector is now only 3.5% of the S&P 500’s market cap (down from a 21st century peak of over 15%), and 4% of EPS (down from over 10% in the early 2010s). Over the last 12 months, the energy sector has lost almost 34% of its value versus the market, which is up (as of close on Friday) 7.25%. However, the energy sector still matters. Consensus was expecting the sector to contribute 5% of the index’s EPS growth in 2020. Now we should expect its earnings to decline. Our rule of thumb: If oil prices stay in the $30 per barrel range, that means we will have to knock down 2020 earnings per share expectations by another $3–$5.

Risk assets desperately needed some good news over the weekend, and they got the opposite. The big question on everyone’s minds is whether or not this will lead to a recession. At this point, markets are starting to say it’s already here. Treasury yields have never been lower, and markets expect the Fed funds rate to be back at zero by July. Last week, high yield and investment grade corporate credit default swaps had some of their worst weeks since the financial crisis, and the news over the weekend will likely exacerbate the move.

The S&P 500 is down over 18% from its all-time highs, and high yield spreads seem to be heading for their 2016 levels. Whether or not the NBER decides to declare that we experienced a recession is almost beside the point. What matters now is how long the global economy will have to deal with a severe shock from both the psychological damage caused by COVID-19 and the side-effects of stringent containment measures. The related decision by OPEC+ to abandon its supply agreement is just another wild card in a game where the rules change every hand.

Risks have increased, and we have made portfolios even more defensive in light of new developments. We are neutral weight equities for the first time in years. We have a full duration position, which benefits from falling rates. Most portfolios do not own directional high yield. Further, nothing about the COVID-19 shock causes us to lose conviction in our high-conviction growth megatrends: digital transformation, healthcare innovation, and sustainability. We believe those areas to drive growth for the next 5–10 years. This shock, even if it does cause a recession, does not change that view.

The volatility of the last few weeks has been relentless, and it seems unlikely that it will subside anytime soon. However, we build portfolios to capture only the amount of volatility necessary to achieve investors’ goals. Long-term investors should remember that periods of volatility and uncertainty are inextricably linked to long-term capital appreciation. This, too, shall pass.

 

 

All market and economic data as of March 2020 and sourced from Bloomberg, FactSet and Gavekal unless otherwise stated.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

RISK CONSIDERATIONS

  • Past performance is not indicative of future results. You may not invest directly in an index.
  • The prices and rates of return are indicative, as they may vary over time based on market conditions.
  • Additional risk considerations exist for all strategies.
  • The information provided herein is not intended as a recommendation of or an offer or solicitation to purchase or sell any investment product or service.
  • Opinions expressed herein may differ from the opinions expressed by other areas of J.P. Morgan. This material should not be regarded as investment research or a J.P. Morgan investment research report.

 

 

 

 

Important Information

All companies referenced are shown for illustrative purposes only, and are not intended as a recommendation or endorsement by J.P. Morgan in this context.

All market and economic data as of March 2020 and sourced from Bloomberg, FactSet and Gavekal unless otherwise stated.

The information presented is not intended to be making value judgments on the preferred outcome of any government decision.

This material is for informational purposes only, and may inform you of certain products and services offered by
J.P. Morgan’s wealth management businesses, part of JPMorgan Chase & Co. (“JPM”). Please read all Important Information.

  • The MSCI China Index captures large- and mid-cap representation across China H shares, B shares, Red chips, P chips and foreign listings (e.g., ADRs). With 459 constituents, the index covers about 85% of this China equity universe. Currently, the index also includes Large Cap A shares represented at 5% of their free float adjusted market capitalization.
  • The Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The index was developed with a base level of 10 for the 1941–43 base period.
  • The STOXX Europe 600 Index tracks 600 publicly traded companies based in one of 18 EU countries. The index includes small-cap, medium-cap and large-cap companies. The countries represented in the index are Austria, Belgium, Denmark, Finland, France, Germany, Greece, Holland, Iceland, Ireland, Italy, Luxembourg, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.

This material is for informational purposes only, and may inform you of certain products and services offered by
J.P. Morgan’s wealth management businesses, part of JPMorgan Chase & Co. (“JPM”). Please read all Important Information.

GENERAL RISKS & CONSIDERATIONS

Any views, strategies or products discussed in this material may not be appropriate for all individuals and are subject to risks. Investors may get back less than they invested, and past performance is not a reliable indicator of future results. Asset allocation does not guarantee a profit or protect against loss. Nothing in this material should be relied upon in isolation for the purpose of making an investment decision. You are urged to consider carefully whether the services, products, asset classes (e.g., equities, fixed income, alternative investments, commodities, etc.) or strategies discussed are suitable to your needs. You must also consider the objectives, risks, charges, and expenses associated with an investment service, product or strategy prior to making an investment decision. For this and more complete information, including discussion of your goals/situation, contact your J.P. Morgan representative.

NON-RELIANCE

Certain information contained in this material is believed to be reliable; however, JPM does not represent or warrant its accuracy, reliability or completeness, or accept any liability for any loss or damage (whether direct or indirect) arising out of the use of all or any part of this material. No representation or warranty should be made with regard to any computations, graphs, tables, diagrams or commentary in this material, which are provided for illustration/reference purposes only. The views, opinions, estimates and strategies expressed in this material constitute our judgment based on current market conditions and are subject to change without notice. JPM assumes no duty to update any information in this material in the event that such information changes. Views, opinions, estimates and strategies expressed herein may differ from those expressed by other areas of JPM, views expressed for other purposes or in other contexts, and this material should not be regarded as a research report. Any projected results and risks are based solely on hypothetical examples cited, and actual results and risks will vary depending on specific circumstances. Forward-looking statements should not be considered as guarantees or predictions of future events.

Nothing in this document shall be construed as giving rise to any duty of care owed to, or advisory relationship with, you or any third party. Nothing in this document shall be regarded as an offer, solicitation, recommendation or advice (whether financial, accounting, legal, tax or other) given by J.P. Morgan and/or its officers or employees, irrespective of whether or not such communication was given at your request. J.P. Morgan and its affiliates and employees do not provide tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any financial transactions.  

IMPORTANT INFORMATION ABOUT YOUR INVESTMENTS AND POTENTIAL CONFLICTS OF INTEREST

Conflicts of interest will arise whenever JPMorgan Chase Bank, N.A. or any of its affiliates (together, “J.P. Morgan”) have an actual or perceived economic or other incentive in its management of our clients’ portfolios to act in a way that benefits J.P. Morgan. Conflicts will result, for example (to the extent the following activities are permitted in your account): (1) when J.P. Morgan invests in an investment product, such as a mutual fund, structured product, separately managed account or hedge fund issued or managed by JPMorgan Chase Bank, N.A. or an affiliate, such as J.P. Morgan Investment Management Inc.; (2) when a J.P. Morgan entity obtains services, including trade execution and trade clearing, from an affiliate; (3) when J.P. Morgan receives payment as a result of purchasing an investment product for a client’s account; or (4) when J.P. Morgan receives payment for providing services (including shareholder servicing, recordkeeping or custody) with respect to investment products purchased for a client’s portfolio. Other conflicts will result because of relationships that J.P. Morgan has with other clients or when J.P. Morgan acts for its own account.

Investment strategies are selected from both J.P. Morgan and third-party asset managers and are subject to a review process by our manager research teams. From this pool of strategies, our portfolio construction teams select those strategies we believe fit our asset allocation goals and forward-looking views in order to meet the portfolio’s investment objective.

As a general matter, we prefer J.P. Morgan managed strategies. We expect the proportion of J.P. Morgan managed strategies will be high (in fact, up to 100 percent) in strategies such as cash and high-quality fixed income, subject to applicable law and any account-specific considerations.

While our internally managed strategies generally align well with our forward-looking views, and we are familiar with the investment processes as well as the risk and compliance philosophy of the firm, it is important to note that

J.P. Morgan receives more overall fees when internally managed strategies are included. We offer the option of choosing to exclude J.P. Morgan managed strategies (other than cash and liquidity products) in certain portfolios.

The Six Circles Funds are U.S.-registered mutual funds managed by J.P. Morgan and sub-advised by third parties. Although considered internally managed strategies, JPMC does not retain a fee for fund management or other fund services. 

LEGAL ENTITY, BRAND & REGULATORY INFORMATION

In the United States, bank deposit accounts and related services, such as checking, savings and bank lending, are offered by JPMorgan Chase Bank, N.A. Member FDIC.

JPMorgan Chase Bank, N.A. and its affiliates (collectively “JPMCB”) offer investment products, which may include bank-managed investment accounts and custody, as part of its trust and fiduciary services. Other investment products and services, such as brokerage and advisory accounts, are offered through J.P. Morgan Securities LLC (“JPMS”), a member of FINRA and SIPC. Annuities are made available through Chase Insurance Agency, Inc. (CIA), a licensed insurance agency, doing business as Chase Insurance Agency Services, Inc. in Florida. JPMCB, JPMS and CIA are affiliated companies under the common control of JPMorgan Chase & Co. Products not available in all states.

References to “J.P. Morgan” are to JPM, its subsidiaries and affiliates worldwide. “J.P. Morgan Private Bank” is the brand name for the private banking business conducted by JPM.

This material is intended for your personal use and should not be circulated to or used by any other person, or duplicated for nonpersonal use, without our permission. If you have any questions or no longer wish to receive these communications, please contact your J.P. Morgan representative. 

© 2020 JPMorgan Chase & Co. All rights reserved.


Check the background of Our Firm and Investment Professionals on FINRA's BrokerCheck

To learn more about J. P. Morgan’s investment business, including our accounts, products and services, as well as our relationship with you, please review our  J.P. Morgan Securities LLC Form CRS and  Guide to Investment Services and Brokerage Products.

This website is for informational purposes only, and not an offer, recommendation or solicitation of any product, strategy service or transaction. Any views, strategies or products discussed on this site may not be appropriate or suitable for all individuals and are subject to risks. Prior to making any investment or financial decisions, an investor should seek individualized advice from a personal financial, legal, tax and other professional advisors that take into account all of the particular facts and circumstances of an investor's own situation. 

This website provides information about the brokerage and investment advisory services provided by J.P. Morgan Securities LLC (“JPMS”). When JPMS acts as a broker-dealer, a client's relationship with us and our duties to the client will be different in some important ways than a client's relationship with us and our duties to the client when we are acting as an investment advisor. A client should carefully read the agreements and disclosures received (including our Form ADV disclosure brochure, if and when applicable) in connection with our provision of services for important information about the capacity in which we will be acting.

INVESTMENT AND INSURANCE PRODUCTS ARE: • NOT FDIC INSURED • NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY • NOT A DEPOSIT OR OTHER OBLIGATION OF, OR GUARANTEED BY, JPMORGAN CHASE BANK, N.A. OR ANY OF ITS AFFILIATES • SUBJECT TO INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF THE PRINCIPAL AMOUNT INVESTED
Equal Housing Opportunity logo

J.P. Morgan Chase Bank N.A., Member FDIC Not a commitment to lend. All extensions of credit are subject to credit approval 

“J.P. Morgan Securities” is a brand name for a wealth management business conducted by JPMorgan Chase & Co. (“JPMC”) and its subsidiaries worldwide. JPMorgan Chase Bank, N.A. and its affiliates (collectively “JPMCB”) offer investment products, which may include bank managed accounts and custody, as part of its trust and fiduciary services. Other investment products and services, such as brokerage and advisory accounts, are offered through J.P. Morgan Securities LLC (“JPMS”), a member of FINRA and SIPC. Annuities are made available through Chase Insurance Agency, Inc. (CIA), a licensed insurance agency, doing business as Chase Insurance Agency Services, Inc. in Florida. JPMCB, JPMS and CIA are affiliated companies under the common control of JPMorgan Chase & Co. Products not available in all states.

Please read additional Important Information in conjunction with these pages.