A new week means a fresh batch of market volatility as oil prices drive the market down, but what exactly is the correlation between the two?
Last week was pretty good, all things considered. The market rose, Gilead Sciences (NASDAQ: GILD) was working on a promising COVID-19 treatment, and infection rates appeared to be in decline.
I already yearn for last week’s optimism.
Monday greeted us with the market opening and eventually closing deep in the red: the Dow (NYSEARCA: DIA) fell 2.4%, the S&P 500 (NYSEARCA: VOO) tumbled 1.8%, and the Nasdaq (NASDAQ: NDAQ) dropped 1%. Things aren’t looking much better today, with all indices pointing to opening drops of 200+ points each.
Unlike previous drops that seemed to be reactive only to coronavirus-related news, there is a concrete reason for this weeks’: oil!
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What happened to the oil market?
The oil and gas industry is an important member of the economy, amounting to $1.7 trillion in 2019, compared to the likes of gold, which is a market estimated to be worth $170 billion. It is estimated that we use 94 million barrels of crude oil per day worldwide. It is a substance that is literally running the planet.
However, what happens when the planet stops running?
Oil demand has plummeted as millions of people are forced into social-distancing restrictions. Top oil stocks are suffering, with the likes of TC Energy (NYSE: TRP), Enterprise Products Partners (NYSE: EPD), and Phillips 66 (NYSE: PSX), amongst others, falling in recent months. Just yesterday, on Monday, 20 April, the U.S. oil benchmark, WTI (West Texas Intermediate), fell below $0 per barrel for the first time ever.
The losses in oil came amid plummeting demand due to the coronavirus pandemic, which is offsetting historic production cuts. West Texas Intermediate crude oil contracts expiring in May fell as much as 321%
How does this affect the stock market?
Much like any big industry, there is a cause and effect relationship with the stock market. As major oil futures contracts expire, traders have been exiting those positions, driving the already low cost of oil to plunge even further, which in turn, causes big oil companies’ stock prices to fall, which then has a knock-on effect on the market to which they belong, such as the Dow.
You might be wondering why tech companies also closed on Monday in the red, as they have nothing to do with oil, right?
Well, technically that’s true, but oil holdings directly affect major banks in the U.S., who have major exposure to the sector through outstanding loans. Just take a look at ‘the big four’s’ exposure as of December 31, 2019:
- Citigroup’s (NYSE: C) exposure is 15%.
- Bank of America (NYSE: BAC) and Wells Fargo (NYSE: WFC) have exposure of 10% each.
- JP Morgan’s (NYSE: JPM) oil and gas loan exposure was 7%.
Failure of the oil sector to repay these loans will directly affect big banks’ net interest margins, increasing loan losses, and price deflation across all of their products. Many of these banks represent a significant portion of the S&P 500 and other benchmark indexes, and hold stakes in other public companies in tech and other sectors.
When the market inevitably falls as a result of the banks’ exposure to oil, it forces investors to weigh up how the virus will affect a slew of technology earnings coming up in the coming weeks. IBM (NYSE: IBM) reported sales declines in its earnings last night, Netflix (NASDAQ: NFLX) is due to report earnings tonight, Snap (NYSE: SNAP), Intel (NASDAQ: INTC) and many more are scheduled for later this week.
How can I limit my portfolio’s exposure to a downturn?
It can be overwhelming to see so much negative news at the moment, and all of this talk of recession would make even the most seasoned investor nervous. However, downturns are a natural part of stock market life, and they all pass with time.
There are ways to limit your exposure to the market, and even benefit from bargain stock prices during the downturn. Suddenly, some of our favorite stocks such as Apple (NASDAQ: AAPL), Microsoft (NASDAQ: MSFT), or Tesla (NASDAQ: TSLA) look like a unique investment opportunity. Despite their stock prices falling with the overall market sell-off, they are still the same companies as they were before, and should come out the other end of this downturn with a long runway for growth.
- Diversify: Accumulate a minimum of 12 stocks across 6 different sectors.
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MyWallSt operates a full disclosure policy. MyWallSt staff currently hold long positions in companies mentioned above. Read our full disclosure policy here.