On Monday, North American stock markets were halted in early trading due to dramatic declines sparked by an oil price war. Russia refused to reduce its oil production, and Saudi Arabia responded by indicating it would increase production and lower prices. West Texas Intermediate crude tumbled to less than US$30 a barrel at one point from more than US$40 Friday.
The S&P/TSX Composite Index is closing in on bear market territory, with the TSX down 19 per cent from its record high reached in February. A bear market is defined as a decline of 20 per cent or more from its peak.
The oil war comes as investors are still reeling from the economic uncertainty and health concerns raised by the outbreak of the new coronavirus, which causes COVID-19.
We spoke with Benjamin Tal, deputy chief economist at CIBC Capital Markets, who shared his perspective during this time of economic uncertainty and fear in the markets.
Markets spiralled down Monday, driven principally by an oil price war.
This is basically political manoeuvring between Russia and Saudi Arabia. I do think that eventually Russia and Saudi Arabia will find a way to achieve a deal – I think there is a high probability that we will reach this point relatively soon. After all, nobody wins in this situation. But in between you have this uncertainty.
This is not a long-term story, but in the short term that potentially is enough to move the economy into a recession if we are not there already. This is clearly a negative for Alberta, and energy is about 10 per cent of our GDP, so that is enough to potentially take the economy into negative territory.
How low can the price of oil go?
It’s not unthinkable that in the near future it can go to between US$20 and US$30 [a barrel]. There is a lot of bearishness in the market. Saudi Arabia will not change its mind tomorrow. It will take time for the U.S. to act as a swing producer. We can reach on a temporary basis US$20 to US$30, but I don’t think this is a sustainable level.
What are your thoughts on the persistent market volatility?
I think the concern is that it might get worse before it gets better because now they are actually testing more people and the numbers will rise. The numbers in China are stabilizing because everybody is at home, and there is the risk that they will start sending people, maybe prematurely, back to work and that can create another wave. Given the uncertainty, you can see this volatility.
The market is trying to figure out what is happening and it will not recover in any significant way before getting the green light, and that might take a while.
What's the green light?
When coronavirus cases stabilize.
If you look at what we have seen in the past with this kind of experience, it basically lasted a few months and then it was over. The specialists that I have spoken to – the doctors, the professors – said it’s 50/50 that it is possible that by May, when temperatures go up, that it will subside the way the flu goes away. But then you have some cases in Australia, so they are not sure to what extent it is seasonal. This adds to the uncertainty, and that is why the market is so nervous.
Do you believe monetary policy is effective or do we really need to see fiscal policy measures announced?
There is no question that the effectiveness of monetary policy, even before the virus, is diminishing. Even in Canada and the U.S., when you start cutting in a low interest rate environment, the marginal effectiveness of the cuts is diminishing because interest rates are low to start with.
You are absolutely right that fiscal policy should be the way to go, with more direct spending – allow the deficit to go up. This fiscal stimulus should basically look at accelerated EI [employment insurance] payments for people who were let go, for people who were sent home and are not being paid, maybe even some special transfer of health money to provinces that probably will need it if the situation gets worse.
With yields plunging to historically low levels, the bond market is telling us that a recession is coming.
Although we are not officially calling for a recession, I think a recession is a real risk. Our official [GDP] call is negative 0.5 per cent or so in the second quarter, 0.8 per cent in the third quarter and then 3 per cent in the fourth quarter – a significant rebound. But if this virus lasts longer than expected, then there will be a recession.
The supply chain, I believe, is the dominant issue economically speaking.
There is a bigger picture here. I think that a year from now, even if we don’t talk about the virus any more, I think this virus is acting as a very important catalyst to the beginning of deglobalization. I think deglobalization started with [U.S. President Donald] Trump. Of course, we are not talking about total deglobalizaiton, we are just talking about modification to the globalization story.
I think that this virus will be a wake-up call for many companies and governments to say: We cannot have a situation where 80 per cent of our antibiotics are coming from China or elsewhere.
What should investors be doing as they try to navigate these extreme market moves?
Panicking at this point and selling is a mistake. I would definitely not be a seller in the equity markets.
If your time horizon is the next month or two, I would be defensive because I believe it can get worse before it gets better.
However, if a year from now you and I are not talking about the coronavirus, then it is very reasonable to assume that there are some good bargains out there. If you have a long-term horizon, I think some good opportunities are emerging. I would focus on quality because usually markets tend to overshoot and do not distinguish between low- and high-quality companies. I would focus on high-quality stocks because they tend to turn around very quickly.
Would you be selling bonds?
I think that the bond market is reacting in a very aggressive way. From a long-term perspective, I would start thinking twice before adding a position in the bond market.
Do you believe we have seen a bottom in equity markets?
No, I don't think so. But we are getting closer.
I think that we have to take a long-term view. Markets tend to overreact. Nobody can time the bottom, nobody can time the peak, and I think that if you have a long-term investment horizon, clearly panicking is not the right thing to do.
I think a year from now, we will look at this dark period and we will say there were some very good opportunities there. The market was simply overreacting the way it does all the time.
This interview has been edited and condensed. An extended version is available on tgam.ca/inside-the-market.