There's No Market Recovery Without an Oil Rally

At least by recent standards, the S&P 500 Index’s 1.01% drop on Monday wasn’t jaw-dropping. But it was still important, because it showed there’s much more driving equities and other risk assets than just the latest headlines on the coronavirus pandemic. Indeed, equities fell even though the head of the Centers for Disease Control and Prevention said the outbreak has stabilized across the U.S.

Amid all the focus on whether Covid-19 infections are accelerating or decelerating, it’s easy to lose sight of the fact that the oil price war between Saudi Arabia and Russia also had a large hand in causing equities to tumble into a bear market in record time. West Texas Intermediate crude went from more than $63 a barrel in early January all the way down to $20 on a closing basis at the end of March. This collapse in prices has made it virtually impossible for many U.S. energy producers to stay in business, let alone generate a profit. Credit-rating firms are forecasting a surge in default rates to around 10% from about 2% before the pandemic, largely as a result of energy companies going bankrupt. Estimates of the cost to keep going for many of these companies depend on oil being in a range of $20 to $40 a barrel, with the latter price closer to the level producers really need. Understanding this dynamic goes a long way to understanding why stocks failed to respond to the historic deal among the world’s top oil producers to cut global petroleum output by almost 10%, putting an end to the devastating price war. The problem is that many economists agree that the drop in oil demand warrants a 20% drop in production. As a result, oil barely budged, with WTI crude rising just 25 cents to $23 a barrel, not even reaching the $28 level it reached earlier this month.