Falling Oil Prices Disrupt the Financial Markets

A sharp drop in oil prices ended the S&P 500’s record-breaking rally.

Lawmakers, business leaders and healthcare professionals around the country are searching for solutions to curtail the spread of COVID-19 and reopen the U.S. economy.

A sharp drop in the price of oil disrupted the financial markets this week, ending a record rally for equities. After the S&P 500 had its best 18-day performance since 1933, it’s not surprising to see the market digest those gains, Chief Investment Officer Larry Adam said.

“Equity markets do not move in a straight, uninterrupted line, especially in an environment predicated on headline news flow,” Adam said. “Continued uncertainty surrounding the timeline for the reduction of social distancing measures and the reopening of the economy, combined with an unprecedented decline in oil prices, led to an uptick in volatility.”

Oil prices dropped precipitously because supply greatly exceeds demand at a time when travel is diminished and much of the world’s population is staying home to help curtail the spread of the virus. The price of West Texas Intermediate (WTI) crude oil – considered the benchmark for the price of oil in the United States – briefly went into negative territory.

“The cause of this highly bizarre situation is a physical lack of storage,” said Energy Analyst Pavel Molchanov. “Storage tanks around the world are becoming saturated.”

The problem is especially severe at a storage hub in Oklahoma, where the WTI price is set. For now, Molchanov suggests the Brent price – considered the global benchmark – is a better reflection of oil industry fundamentals. The Brent price has come down, too, but is less affected by conditions at any single facility.

It’s a strange reality to see oil prices so low at a time when many of us have nowhere to go.

“In past decades, lower oil prices were beneficial to the economy,” Chief Economist Scott Brown said. “Spending less to fill their gas tanks meant consumers had more money to spend on other things. But now we see big hits in energy jobs and capital spending when oil prices fall.”

The sustainable solution to the oil glut is for demand to recover, but with billions of people around the world subjected to lockdowns or stay-at-home orders, no one should expect a “flip the switch” moment, Molchanov said.

The reopening of the U.S. economy, it appears, will be similarly gradual. While state governments balance letting people return to work with the potential for increased COVID-19 cases, the federal government is expected to provide fiscal relief in the form of a fourth stimulus bill. Washington Policy Analyst Ed Mills anticipates another $350 billion in funding for small businesses and $100 billion for the healthcare response to the virus.

“While this is likely to be an interim step, we expect certainty around support for struggling businesses and the appetite for additional action on Capitol Hill to help provide ballast for the current market volatility,” Mills said.

Adam, the firm’s chief investment officer, expects volatility will remain heightened for the near term.

“Favorable news on the medical front – concrete evidence of a reliable therapeutic or vaccine – is the likely next catalyst to push the equity market higher,” Adam said. “Ultimately, assuming a modest rebound in both earnings and economic growth during the second half of the year, we expect the equity market to be higher relative to current levels over the next 12 to 24 months.”

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The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary. Past performance may not be indicative of future results. Investing involves risk, and investors may incur a profit or a loss. Investing in the energy sector involves risks and is not suitable for all investors. All expressions of opinion reflect the judgment of Raymond James and are subject to change. There is no assurance that any of the forecasts mentioned will occur. Economic and market conditions are subject to change.