2020 may be one of the worst years to start with. First, we have COVID-19, and now we have a sudden crash in oil price by > 20% in a day. What is happening? What should I do?
What happened?
The world’s production has already gone down due to COVID-19 as workers are quarantined. Demand is low and hence, it makes sense to cut oil production to keep oil prices steady. However, OPEC and its allies failed to reach an agreement on production cuts in last week meeting. OPEC ally, Russia, also refused to agree to the proposed additional output reduction. Saudi Arabia subsequently announced massive discounts to its official selling prices for April initiating a price war. The oversupply on the oil production is causing oil price to tank.
Impact on the Macroeconomy
Theoretically, low oil price should help in economic growth as oil is a main source of energy powering the world’s production. Low oil price leads to cheaper production as well as lower inflation and consumers will have higher purchasing power for other consumption. However, companies and employees in the oil and gas industries definitely will be severely affected as there will be loss of contracts, lower profit margin and retrenchment. Some companies may even collapse if oil price remains low for an extended period. If many oil companies start to default on their loans, that would affect the other suppliers and creditors like banks. It will start the domino effect throughout the economy.
Oil Price vs Stock Price
Stock investors see this as a first sign of trouble and expect more bad news to unfold. The sudden oil price crash is definitely an event that nobody has predicted, aka, a black swan event. Short term stock market will have more volatility and definitely will look bad. However, there is no direct long-term correlation between oil price and stock price because there are too many factors that will affect the stock market. We cannot really draw any correlation between the two assets.
What would I do?
I am preparing for my another round of capital to invest during this drop. I will allocate my investment capital in defensive sectors like utility, healthcare, telco and finance sectors. I will look at companies with low debt to equity ratio. If the company has strong financial stability with low debt, even with bad short-term financial results, the company is still able to survive in this correction. Healthy operating cash flow is also what I am focusing in. Dividend payout is a plus point as I will continue to receive dividend while waiting for the recovery in stock price.
I am a net buyer of stocks over the years and hence see huge price declines as opportunities to pick them up. It is akin to shopping where I wait for sales to buy what I need or want.
I will try to avoid oil and gas related stocks as the rebound may not be anytime soon. Oil & gas didn’t recover much since 2008 and now the near-term prospect has worsened.
I have done my financial planning well and know what I don’t need this capital for short term. Market always will recover after every correction. I will continue to accumulate my investment asset at lower price and valuation. My situation, investment objective, risky tolerance and views may differ from yours. So, do your own assessment.