By Mark Allara and Kenneth Beanland
Today our domestic equity market suffered its worst one day fall since the Global Financial Crisis(GFC). This type of volatility while unusual, is not unprecedented in equity markets and in this particular case, has bought about by a confluence of events.
Over the weekend the Organisation of Petroleum Exporting Countries (OPEC) had a disagreement on continuing production cuts which concluded with Russia advising they will no longer honour the agreed production limits. This has led to Saudi Ariba announcing they will increase production at a time when demand is at one of the weakest points since the GFC. This has culminated with a 20% drop in the oil price which is the worst one day decline since the Gulf War.
Demand not just for energy but commodities in general has been deteriorating since the out break of COVID19. Markets were relatively immune to the ongoing novel coronavirus outbreak at the beginning however, the rapid spread of cases outside of China has led to a re-evaluation of the risks and with Market valuations at historically high levels, there has been a rapid re pricing of risk. As shown below there may be further to fall to bring a more normal Price to Earnings (PE) level, particularly given the weak earnings outlook which is likely to deteriorate further given global growth concerns over COVID19. Given the recent escalation in Italy where travel from the northern part of the country is being restricted and cases in developed economies continuing to rise, we are anticipating further weakness in the outlook for commodities and energy which has put pressure on the Australian economy.
With global growth under question, we are starting to see signs of stress in credit markets which will be exasperated by the energy market turmoil today. This has seen high yield corporate spreads widen as investors remain on the sidelines. Importantly we view this a something central governments around the world will combat with Quantitative Easing (QE).
After a strong liquidity induced run since the start of 2019 (ASX 200 Acc: +32% to 21-Feb-20) a market pullback was long overdue. It is difficult to predict the magnitude and the duration of this pullback given these events are all fluid in nature. For investors of all experience, this may cause concern around the type of assets they hold, question their investment strategy or the information being presented in the press.
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