U.S. companies buffeted by supply chain chaos and a growing awareness of the scope of a viral outbreak are facing new threats to begin the week. The price of U.S. crude fell as much as 34% to $27.34 a barrel, the lowest price since early 2016, as an oil war between Saudi Arabia and Russia broke out. Typically, falling energy prices are good for markets and for businesses. However, in times of economic duress, energy prices come to be seen as a barometer of the global economy overall. That appeared to be what happened Monday with crude prices suffering the largest single-day decline since the 1991 Gulf War. Here are some of the developments that are affecting businesses and potentially, the economy as a whole.
The Fort Worth Business Press spoke with KC Mathews, chief investment officer with UMB Bank about the effects of the coronavirus and energy prices on the market.
Mathews talked about what the steep drop in energy prices could mean for the economy.
“Most energy companies here in the United States require energy prices to be around $50 dollars a barrel, to make money,” he said. “So, if this is short lived… If this is a negotiation tactic, we’ll be fine. But if it stays down here, there are many smaller oil companies, that are highly leveraged, that could cause them to go out of business.”
Mathews noted we went through something like this in 2914 and 2015.
“[At that time] energy prices dimmed down significantly and we did make it through it. So, we have some evidence that, again, if it’s short lived, these companies will survive. But energy today is a relatively small exposure in the S&P 500. You’re only at about 3 or 4%.
“But energy has been a big spender with CapEx [capital expenditures] and if they’re not going to make any money, they’re not going to spend. And that has economic implications.”
Mathews also noted that North Texas is not as dependent on the energy industry as it was several years ago.
“When you analyze the Dallas and Fort Worth economies, they become so diversified from years ago. It will be impacted, but not to the magnitude of years and years ago,” he said.
Mathews noted that the number of new cases of coronavirus or Covid-19 are going down in China.
“It appears they have stabilized the situation and you look at the capacities of factories, traffic congestion, electricity usage, it’s all starting to say maybe there are factories that are about 50%… It will probably take a couple of weeks to get back 100%,” he said.
“In China, they quarantined millions of people. Shut down cities,” he said. “And I think it contained the spread of the disease. But I think that’s relatively easy to do under a dictatorship as opposed to a democracy.”
If the same pattern holds in the United States, Mathews sees another couple of weeks of the disease spreading.
“You’ll get bombarded with information on new cases every day,” he said. “And that’s where I think it’ll keep impacting the stock market and the bond market, looking for a safe harbor. And then, once we get to that number plateauing – if it’s going to be a similar pattern to China, you’re a couple weeks out and then we’re on the mends.”
But he noted the risk is “totally unknown.”
If it continues spreading in the U.S. for several months, “then all of sudden corporate earnings start to dry up,” he said.
As a result, Mathews said they have been “a little defensive going into this market at the beginning of the year, due to valuation that I spoke to earlier,” he said.
“Then last week, we just continued to reduce risk and just go into cash,” he said.
On the energy side, he said they are looking at companies’ balance sheets and “making sure we own sustainable companies.”
The message to clients is to make sure “you own good stocks, good quality stocks.”
Mathews noted how different the market looked just a few weeks back.
“We had a triple threat. We had valuation in play with risk-based markets. We had the COVID-19 developing and we had geopolitical risks, not only with trade negotiations, and then you also had the U.S. Presidential Election.”
Early in the year, he noted, the market was priced at 18 and a half times earnings.
“We know corrections are just natural and healthy for bull markets, and we haven’t seen a correction in well over a year. So, at first, I would’ve said, ‘We’re probably due for something between a 10 and 20% correction in the marketplace.’ That’s just based on valuations. Then, you throw in the trade issues.”
Some of the trade tensions were de-escalating, Matthews noted, which was “a little bit of a positive.”
In the geopolitical sphere, Mathews noted there were some tensions with a potential presidential candidate talking about raising corporate tax rates from 21% to 35%.
“Then, of course, the market did get some relief when the leadership changed to a more moderate candidate,” he said.