Global CIO Commentary by Scott Minerd
In just one week, oil prices skidded by more than 10 percent, sparking a sell-off in U.S. equities of 3.5 percent, a Treasury rally of more than 20 basis points, and global headlines of growth fears and tumult. Surprisingly, I’m not talking about this week. The week I’m referring to was in early December, and it is rather similar to the present oil price action and market response.
During the week of Dec. 8, oil fell 12.2 percent to around $58 a barrel, the yield on U.S. 10-year Treasuries approached 2 percent from around 2.30 percent, and equities declined over 3.5 percent. At that time, I published a commentary establishing a downside target for oil at $50 a barrel and said that the yield on the U.S. 10-year note would slip further to around 1.9 percent. Many of those predictions seemed pretty extreme at the time, but here we stand. At the time of writing, oil is around $48 per barrel, and the yield on U.S. 10-year Treasuries is 1.96 percent.
Technically speaking, after breaking through the support level of $50 a barrel, the measured move for oil is now $34 a barrel (based on the minimum downside potential price according to the rules used by market technicians). I believe we are in for a prolonged period where oil trades in the $40 to $50 range and possibly lower. In fact, I have the investment teams running stress tests based on oil trading at $25 a barrel for an extended period of time.
Twenty-five dollars a barrel? Isn’t that a bit extreme? I would guess, but so were our stress tests in 2008, which assumed short-term rates could go to zero for an extended period of time. The current bear market for oil is the result of a supply shock brought on by fracking. Based on the unwillingness of global oil producers to reduce production, the current supply shock will take a while to work its way through the system, and oil prices have yet to find a bottom. Better to evaluate the downside scenarios now than to be unprepared.
The difference between this bear market in black gold and the bear market of 2008 or the 1998 experience, which was associated with the Asian crisis, is that both of those were demand shocks. The best historical comparison to what we’re witnessing today in oil prices is actually the supply-shocked world of the mid-1980s.
The 1985-86 bear market in oil was the result of oversupply—too much oil was brought online relative to demand. During that period, prices declined more than 67 percent over four months or so. When oil prices started to rise again in April 1986, credit spreads started to tighten a few months later and within 12 months, the stock market was up over 20 percent. If history is any guide—and in this instance, I believe it may be—we are likely to see a similar situation play out today.
But investors beware in the near-term. Even at $48 per barrel, oil is still a falling knife—I believe there remains another significant downside move. If we hit the $34 a barrel price target, which I believe we could, that would be another 30 percent decline in oil prices. Typically, people would rightly characterize a 30 percent decline as a bear market. We’ve already had a decline of over 55 percent from the high, so we’ve already been in a bear market, but if we started over today we’re going to have another one.
With the development of fracking, we’ve had a huge increase in the supply of oil. By most estimates, fracking ceases to be profitable when oil prices hit somewhere in the neighborhood of $40 a barrel. Once the frackers stop drilling new wells, the following 24 months should see oil output gradually declining, allowing for prices to stabilize and ultimately rising to something viewed as normal above $60. Until supply begins to contract, oil will continue to languish. Between now and then, anything energy output-related should continue to suffer from weak oil prices.
Guggenheim Investments represents the investment management businesses of Guggenheim Partners, LLC ("Guggenheim"). Guggenheim Funds Distributors, LLC is an affiliate of Guggenheim.
Read a prospectus and summary prospectus (if available) carefully before investing. It contains the investment objective, risks charges, expenses and the other information, which should be considered carefully before investing. To obtain a prospectus and summary prospectus (if available) click here or call 800.820.0888.
Investing involves risk, including the possible loss of principal.
*Assets under management is as of 09.30.2018 and includes leverage of $11.8bn.
Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Corporate Funding, LLC, Guggenheim Partners Europe Limited, GS GAMMA Advisors, LLC, and Guggenheim Partners India Management. Securities offered through Guggenheim Funds Distributors, LLC.
Guggenheim Investments. All rights reserved.
Research our firm with FINRA Broker Check.
• Not FDIC Insured • No Bank Guarantee • May Lose Value
This website is directed to and intended for use by citizens or residents of the United States of America only. The material provided on this website is not intended as a recommendation or as investment advice of any kind, including in connection with rollovers, transfers, and distributions. Such material is not provided in a fiduciary capacity, may not be relied upon for or in connection with the making of investment decisions, and does not constitute a solicitation of an offer to buy or sell securities. All content has been provided for informational or educational purposes only and is not intended to be and should not be construed as legal or tax advice and/or a legal opinion. Always consult a financial, tax and/or legal professional regarding your specific situation. Investing involves risk, including the possible loss of principal.