March 9, 2020 – 9am –

While I am not sure yet how the media will spin this morning’s significant gap down opening in the market, the reality is the markets are now suffering a second blow, beyond the already challenging coronavirus. Over the weekend, talks broke down between OPEC and Russia regarding a production cut to assist with declining demand due to the virus. In basic terms, OPEC, led by Saudi Arabia sought a production cut but required Russia’s compliance. At present, OPEC is responsible for around 30% of global production, yielding much less influence than it once had years ago. Non-member Russia, responsible for producing upwards of 12% of the global oil supply, did not agree with this proposed cut wielding what may be the last blow to this once influential organization. I concur that this strategy could easily be seen as an attack on the US.  More on this in a moment. 

In response to Russia, founding OPEC member, Saudi Arabia, has decided to respond by further increasing production, in addition it is looking to sell oil below market pricing. In a dramatic deviation from their original plan, Saudi Arabia has responded with a declaration of an oil war, seeking to drive down prices and punish Russia’s non-compliance. 

The result of this is an oil crash which I’ve been witnessing overnight, as crude futures have traded lower, by as much as 30% and, as I write, leveling off to around 20%. Market pundits are immediately shifting their focus onto the already beleaguered oil and gas industry, specifically their extremely high levels of debt. The general consensus is that a crash in oil prices will lead to a debt crisis in the sector and ultimately send many companies operating with high levels of debt and thin margins out of business. In addition, this ‘high-yielding’ debt has made its way into countless pensions, endowments and other institutions seeking a greater yield over and above the paltry rates offered by investment grade or US treasuries. In summary, the connections go as follows: Oil crash → Oil Sector Decline → Debt Issues → Institutional Investment Declines.

There is a silver lining, and my curiosity wonders whether it will be enough. Very soon, you will be filling up your gas tanks at prices you haven’t seen in many years. This will be a boon to the general consumer. Furthermore, with the US producing over 15 billion barrels per day, we are no longer reliant on foreign oil and should act to protect our industry not to reverse this course. With interest rates already at rock bottom levels, this may help many companies refinance debt at lower rates, thus avoiding any short term financing issues. 

I’ve been in this business a long time and, while the headlines are never the same, the history definitely seems to rhyme. Much of our investment management is done with unbiased, objective rules which have been crafted and honed over the years. While not always perfect, these rules have allowed us to successfully navigate the markets for a long time. On Friday, our models switched from a longer-term bull market to bear, which mandated some selling in our general managed accounts, despite having just committed some of the cash we were saving a week prior. Reducing exposure on Friday was not easy to do as the market looked, felt and was acting extremely oversold. Of course we always wish we were more defensive during a decline, I’m pleased to have taken some action when we did. 

At present, my strategy is to sit tight and wait patiently for the panic to subside. We will  approach this manic environment with a cool head and steady hand. As the market searches for clarity among the chaos, and until we see more clarity in the future, our goal will be to do less and not more.