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Oil price drop

A boon for buyers?

13 May 2020

Our Chief Investment Officer discusses the historic drop in oil price and what signal this sends to investors.

The current landscape

For the first time in recorded history the front month contract for West Texas Intermediate turned sharply negative. This was due to attempts to contain the coronavirus which decimated the global demand for oil as well as the shortage of space to store the excess supply. Since then, we have seen a slight pick-up in demand from China and other economies.

As ever, we do not claim to be able to call the bottom of the market. What we can say is that prices appear to be much more balanced in terms of the implied range of probable outcomes than what we saw a month ago. What this means for investors however, is that there is now less of a cushion to absorb any new bad news.

In terms of portfolio positioning, we added significant exposure to stocks and risky parts of the credit complex as the compensation on offer was simply too attractive to pass up. Following the significant rally over the last month or so, we have been paring back our exposure to risk assets and Emerging Markets Equities in particular. We continue to scour the world for opportunities to add value for our clients.

As ever, we recommend investors get invested, stay invested and stay diversified.

Is the oil price drop a boon for buyers?

As part of our aim to keep clients informed of our current investment views and how these themes are impacting your discretionary portfolios, Phil Attreed, Head of Investment Consulting, talks to Will Hobbs, Chief Investment Officer, about the slump in the oil price and recent changes in portfolio positioning.

Phil: Hello and welcome to May's edition of Monthly Market Insights. I'm Phil Attreed, Barclay's Head of Investment Consulting, and I'm joined today by the familiar face of Will Hobbs, our Chief Investment Officer. We hope that you and those close to you are keeping well in these challenging times as we all adapt to a new normal. Will, there's a lot going on in markets right now, it's difficult to keep track, but I guess when it comes to reflecting on this crisis, the last month since we last recorded may well be known as the one where oil went negative?

 

Will: Yes, certainly, Phil that's only one of the jaw-dropping market moves that we've seen in the last period. For the first time in recorded human history or recorded history at the front month contract for West Texas Intermediate turned sharply negative. Now there are a couple of points to make here I think and important context points. Like many other market prices, the prices for oil are set by the rough equilibrium between demand and supply. Now obviously the coronavirus and the attempts to contain it have absolutely decimated the global demand for oil and in terms of the supply side, the ability to meaningfully curtail production in order to find a new equilibrium for prices has been hampered by a number of factors. High on that list is the rapid re-emergence of the US as a major oil producer over the last decade. US production had been on a downward trajectory since the early 1970s really, but suddenly emerging technology, shale technology, opened up a huge resource for US production and US production has soared from really 2007 onwards. But really all of this demand supply story left people wondering whether they were going to have enough room to store all the excess supply. Now the second point really is, a batch of technical explanations or technical factors, and these are more to do with the way that certain crude oil contract, futures contracts, involve the physical delivery of actual barrels of oil when that contracts expires. So in a world where you're running out of room to store all the excess supply, physical delivery was obviously unpopular as the negative prices for the May contract showed for WTI. Now we're actually been seeing the market settle a little bit in the most recent trading days as there has now been a bit of a supply response and you should see that demand start to recover. You're starting to see China and other economies that have been through the first round of infections, you're starting to see oil demand pick back up and over the next six months you won't reach levels in terms of oil demand where you weren't previously, but you should be above where you are today. So we may be through the worst in the oil market, we shall see.

 

Phil: But Will, while oil prices were collapsing, many other assets that had been beaten up as we saw the pretty severe falls in March, such as stocks and lower quality bonds, staged a pretty impressive recovery and with those oil price falls, I can certainly understand why many investors might find this contradiction a little confusing. What are your thoughts on that?

 

Will: So, yes, Phil there are some specific aspects to the oil markets plight. We're not too surprised about the diverging fortunes here. I guess in terms of that bounce-back in stocks and other economically sensitive assets, one way of viewing it is simply a change of emphasis. Now for much of April if you remember investors were really grappling with just how bad this could get, the terrible experience of northern Italy, Lombardi region in particular, was extrapolated to the rest of the world in terms of this is what they might experience. However, as you found time passing, it became clear that Lombardi was not an appropriate case study from which to extrapolate to the rest of the world. You actually found that health care capacity elsewhere so far stood up to the tests more or less, containment has worked, and policymakers have responded forcefully to beef up both social security as social safety nets and indeed life support for failing businesses. So whereas we started the month with most investors really focusing in our opinion too much on really bleak and quite unlikely economic outlooks, we finished the month in a more balanced frame of mind helped by events but also just a slight reassessment.

 

Phil: So I know, Will, you hate any sort of chat about calling the bottom of markets, but how do you and the team see the next six to 12 months playing out and do you think we may have seen the worst for equity markets?

 

Will: Well, yes I think this is important because the very concept of calling the bottom implies that we or I or anyone can see the future at which sadly I cannot and neither can anyone in our team. And I don't think really anyone can anywhere. I think what we can say is that market prices are much more balanced in terms of the implied range of probable outcomes than it was a month ago and that means that there is a bit less cushion to absorb new bad news potentially. But we probably can't say that much more than that.

 

Phil: Will, unsurprisingly you and the asset allocation team have been pretty active in portfolios over the last couple of months. Do you want to just touch on a few of the highlights and how that's been playing out in portfolios for you?

 

Will: Yes Phil, it has been a really busy period because with these markets tend to come more opportunities to add to performance than you might usually find. So a month ago the compensation on offer for stocks for owning stocks and risky parts of the credit world was simply too attractive to pass up in our opinion, so we added significant exposure back to our multi-asset class funds and portfolios. However, following the sizable rally, the really massive rally over the last month or so, that implied compensation on offer is a bit less jaw-dropping that it was; so we actually spent the last week or so paring back our exposure to risk assets particularly, emerging market equities. Now we still think there's opportunities out there, there's plenty of them, it's just they're a bit less stark than they were in the middle of April at that point in time. But we're keeping our eyes very much open and the team continues to scour the world for opportunities to add value for clients.

 

Phil: Thanks, Will, useful insight as always to get us through another month. That just leaves me to thank you, our viewers, for joining us and if you would like to keep in touch with our views and thoughts on developments in the course of the next month, please do seek out our podcast 'Word on the Street'. Otherwise we look forward to you joining us again next month.

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