David Feldman

Oil Must Lead the Way

Blog Post created by David Feldman Champion on Feb 25, 2016

Even though we’re all enjoying the low prices at the gas pump, the oil industry continues to suffer and dangerously walk the line of multiple bankruptcies.  Additionally the weak oil exporting countries move toward default.  And even though it’s nice to save a few bucks each month on gas, the reality of our situation is that if oil stays this low, the detriments far outweigh the pocket change we save.

 

Let me explain. 

 

When oil prices linger so low, the markets interpret this as an uncertain global environment – higher risk, less security. The question then becomes: what happens when investors perceive their money is sitting in high risk investments? The answer is simple: they move it to lower risk options.  People sell stocks and either hold cash, or park their capital in low risk assets such as U.S. Treasuries.  You can see the results of this by looking at the U.S. 10 year yields.  As more and more capital flocks to these safe havens, it pushes the yields lower and lower.   Case in point, since December when the Fed raised rates the yield has dropped 45 basis points from 2.20% to 1.75%. 


Sour
ce: Reuters, Forbes Billionaire’s Portfolio

 

So what will bring back more certainty and stabilization? What will restore confidence in the market again?  The answer is simple.  Wherever oil goes, the market will follow (at least in this current environment). Here’s another chart showing the price of oil compared to the 10 year yield.  As oil prices dropped over the last few months, yields have shortly thereafter followed. 

 

Source: Reuters, Forbes Billionaire’s Portfolio

 

For further proof take a look at this chart that shows the S&P 500 vs. Crude Oil.


Source: Reuters, Forbes Billionaire’s Portfolio

It’s becoming increasingly evident that the risk of defaults across the oil industry from low prices is a key driver for U.S. and global markets.  Simply put, all eyes are on oil!

 

Knowing this, OPEC seems to be working toward a solution.  Five of OPEC's 13 members (and Russia), have agreed to keep output steady at January levels. The hope is that by freezing production the countries will be able to cut into the global oversupply, and save their endangered economies.  However, on the flip side, oil markets continue to remain fragile with wildcards such as Iran attempting to ramp up production fresh off their sanctions being lifted, and Saudi Arabia reporting it’s not prepared to cut output. 

 

To avoid another global financial crisis, it’s imperative that someone does something to drive up oil prices.  Everyone will be watching to see if OPEC’s plan works.  If it doesn’t, other more drastic solutions should be considered such as central banks stepping in.  The solution may not be clear at this point, but one thing is clear: Oil must lead the way!

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