Streetwise Professor

March 9, 2020

Why Are Equities and Oil Moving the Same Direction After an Oil Supply Shock?

Filed under: Economics,Energy,Russia — cpirrong @ 9:42 am

The collapse in oil prices is completely understandable. The co-movement in equity and bond yields is harder to fathom.

As I noted in a previous post, the initial sell-off in oil was driven by corona-related demand declines. One thing interesting at the time was that equities did not respond similarly, which suggested that the prevailing view was that the situation would be contained in China. The last few weeks, equities and bond yields caught up, presumably due to the spread of the virus outside of China (especially in Italy).

The main oil-related news was a big supply shock–the prospect for higher Saudi and Russian output. But this should be positive for the economy overall, and thus for equities. There does not seem to be any new virus-related news that would lead to predictions of a sharp reduction in incomes and output. So, by itself, the oil supply shock should not cause a large sell-off in equities and big buying of bonds. But that is what we are seeing.

One can imagine other channels, e.g., losses on oil positions causing liquidation of equity positions. But the oil markets likely aren’t large enough to trigger such a reaction, and this channel would require those who are long equities to be long oil too–and in a big way in both.

Focusing on the oil supply shock in particular, I wonder if Putin and the Russians expected the furious Saudi reaction. The ruble is down 5+ percent today. Amusingly, Russian cat’s paw Zerohedge is claiming that Putin is all copacetic with this, saying that Russia can survive $25/bbl oil prices for a decade.

This is putting a brave face on things. And those with long memories will recall similar statements during the 2008-2009 collapse–statements that proved laughably false.

It is also interesting to note that Russian expressions of confidence relate to the state budget. Maybe the fiscal frugality has indeed positioned the government to live lean. The populace, not so much. But that’s very revealing about the mindset of the Russian ruling class: it is all about the state, utterly state-centric, and largely dismissive of the citizenry. And it has been so, as long as there has been a Russia.

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  1. One can over think this i think(!). Initial panics / selloffs about raising liquidity but seem to me about just fear – all correlations going to 1. If the circuit breaker hadn’t been installed we might be seeing the 87 futures driven scenario, possibly. As it is everyone will have a trauma about deflation but barring stupidities (a big assumption, I know)’ the technicals should be clear in three days and the following narrative COULD be taken up:
    1. Putin is f—–.
    2. The Turks are f—–.
    3. There should be some realization somewhere that strategic retention of selected capacities (Medical, electronic, etc.) Might be a good idea.
    4. The narrative of the Chinese miracle and that great humanitarian Emperor for Life Winnie the Pooh will continue to look for and more rediculous.
    5. Distress in the Frackers will be real but a lot of it will be in banks and bond buyers who should have known better.
    6. The beginnings of strategic industrialization might occur.
    7. The Chinese Municipal SPV junk bond market will require bigger and bigger bailouts in $ that Beijing will have trouble with. Again the buyers should have known better.
    8. The Mullahs are f—–.
    9. Hezbollah and other clients are f——.
    10. Etc.

    If course we should never underestimate our ability to screw up, particularly in an election year, nor that there will be domestic pain,but as crises go this one does have some upside.

    Comment by Sotos y1 — March 9, 2020 @ 10:17 am

  2. I’m guessing the news that a good portion of your working population may have to self-isolate for weeks or more, a teetering healthcare system, and disrupted supply chains for everything from toilet roll & hand sanitizer to generic drugs & oxygen therapy paraphernalia, isn’t exactly offsetting the drop in oil price.

    Comment by David Mercer — March 9, 2020 @ 11:07 am

  3. @sotos You’re on the money with your point 6. Seems bizarre to think that the US, China, Europe etc have gone to great lengths to secure strategic resources to support their industries (& military), but have completely overlooked critical healthcare supplies.

    Comment by David Mercer — March 9, 2020 @ 11:13 am

  4. @SWP…that comment about ZH was a good one. You can count on them for the Russian POV.
    I also like to keep count of the ‘death of the dollar’ ZH posts. Goes back years. I am at 701.
    Look for a future post in which a virologist says that finding a virus on a $100 bill could mean the end of the dollar as a reserve currency. 702!

    Comment by Richard Whitney — March 9, 2020 @ 3:44 pm

  5. A decade of $25 oil would bankrupt Russia.

    Comment by The Pilot — March 9, 2020 @ 4:43 pm

  6. @The Pilot. A couple of years of $25 oil would bankrupt Russia.

    Putin misjudged MbS. He’s trying to put on a brave face. But he’s effed.

    Comment by cpirrong — March 9, 2020 @ 9:14 pm

  7. Even just having the price where it is today points out Putin’s vulnerability. Not helpful now.a real loss of face internally and will throw a major flapping of sphincters in his clients. The longer the better of course, but still useful in the short run too.

    Comment by Sotos y1 — March 9, 2020 @ 9:42 pm

  8. Not to worry, the Russian propaganda is focusing on the fall of NOK (even as RUR is falling relative to NOK) as well as the obvious fact that true patriots don’t need’em stinkin’ dollars. Apart from that, there will soon be mass gatherings to celebrate the imminent bankruptcy of US shale.

    Comment by Ivan — March 10, 2020 @ 12:07 am

  9. I see the Russians have requested to reconvene with OPEC. Well that went well.

    @Sotos Its the Petrodollar. Correct terminology please.

    Comment by David Mercer — March 10, 2020 @ 10:31 am

  10. To David Mercer. – my bad!

    Comment by sotos — March 10, 2020 @ 10:35 am

  11. Now, Putin has backed (as if it wasn’t his idea) a proposal to amend the Russian constitution to allow him to stay in power until 2036. What could go wrong?

    Comment by The Pilot — March 10, 2020 @ 2:37 pm

  12. @The Pilot. After reading stories about Putin’s puppets proposing to amend the Constitution and about Biden’s latest display of senescence, I had this mental image of a Bidenesque Putin, babbling away in, say, 2028. Think if Biden wins, then the 3 greatest nuclear powers could be led by senile narcissists (Biden, Putin, Xi). Won’t that be fun!

    Comment by cpirrong — March 10, 2020 @ 7:18 pm

  13. Goes to show how seriously unserious the public, world-wide, has become since the bi-polar superpower race ended in 1991. Complacency and sentimentally has overtaken critical thinking as to what makes economies and politics run.

    Comment by The Pilot — March 10, 2020 @ 8:27 pm

  14. When will the third shoe drop? As surplus nations have built reserves in good times their budgets are overburdened. By social prgrammes in Saudi, military in Russia, infrastructure in China, etc. So can we expect a liquidation of bonds to pay for it, causing carnage in bond markets in deficit countries, Professor?

    Comment by philip — March 10, 2020 @ 11:23 pm

  15. “then the 3 greatest nuclear powers could be led by senile narcissists”

    We’re a third of the way there already.

    Putin stated, without even a hint of irony, that Russia wasn’t ‘politically mature’ enough for him to stand down. A second career in stand-up comedy beckons. Maybe he and Donnie could have a show in Las Vegas in their twilight years? You guys would love it.

    Comment by David Mercer — March 11, 2020 @ 2:43 am

  16. @David Mercer. Trump is a narcissist, but not senile.

    Re Putin, he also said that Russians are a “state-forming people,” by implication excluding other nationalities within Russia’s borders. (He used the word that in Russian implies ethnic Russian.). Ironically, apropos your point, he apparently believes that this ancient state-forming people is too politically immature to be trusted with having a voice in the transfer of executive power.

    Comment by cpirrong — March 11, 2020 @ 3:23 pm

  17. In Putin’s mind why would the Russians need to? As Rudolph Hess once said about another leader: Putin is Russia and Russia is Putin! Hail Victory. Or maybe just the Slave (glory) chorus from the opera Boris Gudanov

    Comment by Sotos y1 — March 12, 2020 @ 8:38 am

  18. And crypto down 48%

    Is there NO safe haven?

    VP VVP

    Comment by Vlad — March 12, 2020 @ 9:20 pm

  19. @Vlad. Nope. None. I will post on this tonight. Stay tuned!

    Comment by cpirrong — March 13, 2020 @ 3:24 pm

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