Editor’s Note: The global oil crash continues to roil markets worldwide… terrifying investors. So today, we turn to PBRG’s own Big “T”—Mega Trends Investing Editor Teeka Tiwari—to discuss the implications of oil’s plunge on the economy and investors’ portfolios…
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J. Reeves, editor, The Palm Beach Daily: Teeka, oil fell below $27 per barrel last week. That’s a drop of more than 75% from its June 2014 high of $106.
It’s one of the most amazing commodities crashes of all time.
What caused the sell-off? Where do you see the bottom for oil prices?
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Teeka Tiwari, editor, Mega Trends Investing: An oversupply of oil caused the sell-off. Several factors came together to create a “perfect storm” in the oil market:
- The U.S shale oil “fracking” revolution unlocked enormous quantities of domestic oil. America is the world’s largest oil producer once again.
- Saudi Arabia entered an “oil war” against U.S. shale oil by keeping production high (in order to preserve its global market share).
- The end of long-standing sanctions on Iran means a fresh influx of even more oil to the global market.
- A slowdown in oil demand from the “world’s workshop,” China.
It’s a perfect bearish setup. It will take oil down to $20 a barrel.
J.R.: You’ve said up to one-third of all American oil exploration and production (E&P) companies may file for bankruptcy with $20 oil.
How will this impact the stock and bond markets? Which do you think is most vulnerable?
Teeka: I’m concerned about both markets.
The high-yield “junk” bond market will collapse. Many investors will lose 100% of their money in oil company junk bonds.
That’s because the smaller to mid-sized oil companies require $60-plus oil just to break even. They won’t survive on $20 oil.
Stock prices will also get hit hard over the short (and intermediate) term. But unlike oil junk bonds, they will recover.
J.R.: A recent Bloomberg article pointed to the similarities between the oil crash and last decade’s subprime housing collapse… which ushered in the Great Recession.
Do you see oil’s crash sparking a new systemic credit contraction/banking crisis?
Teeka: The similarity is only surface deep. The U.S. housing mortgage market is over $10 trillion. The entire junk bond market is “only” $2 trillion.
Almost every homeowner—70 million households—saw his/her home’s value drop by an average of 30%. Everyone felt that hit.
I don’t have the exact figures on how many U.S. households own junk bonds… but it’s a lot less than 70 million.
So no, a collapse in junk bonds won’t cause a 2008-2009 systemic breakdown of the financial system.
But it will create some short-term panic.
I predicted this exact thing on December 23. I said a collapse in oil prices would trigger a rout on the junk bond market. The junk bond rout would then spill over into the stock market.
The S&P 500 was at 2,064. I said it would go to 1,800 and then bounce. On January 20, we hit 1,812 and started to rally.
I expect the market will rally a little bit here… then roll over again. The S&P 500 will attempt to retest the 1,800-1,812 level.
If the S&P fails to hold that 1,800-1,812 level, we’ll see it drop to 1,600. That would be a peak-to-valley drop of over 26%… and it will feel like hell to go through. But it will be temporary…
The markets will see a full recovery by the end of 2016.
I went through almost the exact same situation in 1990-1991. (But then, we were dealing with an oil price spike, not a collapse.)
Like today, junk bonds were crashing, and the S&P 500 fell 20%. Sentiment was bleak. We even went into a short recession.
But here’s the important part: One year later, the S&P 500 broke out to new all-time highs.
The 1990-1991 period was a cyclical bear market inside a larger secular bull market. Remember, markets don’t move in straight lines. There can be several short-term sell-offs inside a larger long-term bull market.
We may be in another cyclical bear market right now. But remember: the long-term (secular) trend is up.
That means the bear markets will be short, sharp, and scary… but we’ll quickly recover to new highs. Just like we did during the last great secular bull market from 1982-2000.
(For details on why I know we’re in a secular bull market, read my Golden Ratio report.)
J.R.: You’ve said low oil prices act like a massive tax cut across the broad economy—they have a broad stimulative effect. But much of U.S. employment growth since 2008 came from the “oil patch.”
How will the oil bust impact the U.S. economy?
Teeka: Over the short term, we may see a bigger negative impact on the economy. That’s because of what’s going on in China and other emerging markets.
Their economies are crashing. To fight this, they’re in a race to devalue their currencies. This makes U.S. goods more expensive to overseas buyers… and could put a serious crimp in the S&P 500’s earnings.
This currency effect—along with the crashing earnings numbers from oil companies—will temporarily push stock prices lower. That brings with it a short-term drag on the economy.
Could the oil crash be enough to tip us into a recession? It’s possible. But even if we showed two quarters of negative GDP growth, it would be a temporary slowdown.
The benefits of expensive oil affect about 600,000 workers. But lower energy prices benefit another 143.4 million workers.
So you can see cheap energy is a much better deal for the average worker than expensive energy… and for the U.S economy overall.
J.R.: How can investors stay safe in these volatile times? Where do you see the greatest investment opportunities now?
Teeka: Get off margin (i.e., don’t borrow to invest)… cut your short-term trading-position sizes in half… accumulate cash… and be patient.
This is where my old adage “Let the game come to you” comes into play. If you have stocks you love and you want to get long, let the market come to you. Don’t chase stock prices. Ever.
J.R.: Great advice. Thanks for your time and insight, Teeka.
Teeka: My pleasure.