18,000 Remains Elusive for the Dow as Investors Sent Scrambling for Cover
The Dow Jones industrial index has been hit hard by slumping oil prices around the world. Analysts are expecting global oil supply to outstrip demand well into 2015. Recently, the price of oil dropped precipitously – almost $2 per barrel – as it hit a 5-year low. Owing to OPEC's decision not to reduce the oil supply, many energy companies are taking a hammering on the stock exchange. Investor fears were fuelled by a Morgan Stanley report stating that oversupply will continue into the New Year. According to the Morgan Stanley report, the price of oil could drop as low as $43 per barrel – a figure not seen in decades. The Brent base case outlook for 2015 has dropped from $98 to $70, while the Brent base case outlook for 2016 has dropped from $102 to $88. The price of oil is hitting home with plenty of force. Producers are under heavy pressure to continue supplying at 5-year lows, while consumers are lapping it up in their droves.
Analysts from Banc De Binary expect the lower oil prices to drive retail spending during the holiday season. With big cost savings at the pump, consumers will have more disposable income to shelve out for December shopping. With oil prices as low as they are, China has been buying up oil at a frantic rate as purchases increased by 9% during November. This suggests that China – the world's largest economy according to a new IMF report –Â is stockpiling oil, but Chinese imports are down and Chinese exports are down. Unrelated to the price of oil, but exerting downward pressure on the markets was a loss of confidence in McDonald's (MCD)Â stock. This blue-chip index stock dropped 3.8 percentage points to close at $92.61 for the day, on the back of declining U.S. sales and poorer than expected earnings around the world.
How the oil price is affecting the global economy
There is no doubt that plunging oil prices have a positive effect on the global economy, since consumers are the ones who benefit most from lower gas prices at the pump. This is especially true in consumer oriented economies such as the U.S., Canada and the UK, among others. But all is not well for the emerging market economies that are producing oil – countries like Nigeria, Libya, Algeria, Indonesia and others. These nations are heavily dependent on oil, but they are unable to operate profitably at current oil prices. As such, they will be incurring substantial losses and eating into their reserves to keep their oil production going. Eventually however it will become completely unprofitable for these countries to produce oil at 5-year low prices. Another perspective on the historically low oil price is that global demand is low, in addition to excessive oversupply. This is a result of widespread recessionary fears in Europe, Japan and other parts of the world.
Shockwaves felt far and wide
During the day’s trading on Monday, the Dow Jones industrial index dropped over 100 points, dragging it further away from the elusive 18,000 figure. The rout was led by declines in the energy sector, fuelled by weak Chinese trade data and increasing fears about the depth of the recession that Japan is going through. Combined, this plethora of negative forces sent shockwaves through the markets around the world. The Dow Jones dropped to 17,852 points, led by heavy declines in the blue-chip index with Exxon Mobil (XOM) and Chevron (CVX, Financial) dropping 2.3% and 3.8% respectively Exxon Mobil drop from $93.82 per share and closed at $91.70 per share. Chevron opened the day at $110.87 per share and closed the day at $106.80 per share.
Both the NASDAQ composite index and the S&P 500 index shed at least 0.7% in the day's trading. The effects of the oil price declines sent investors into a tailspin, as they began dumping energy service companies and shares of drilling companies. European stocks also went South, after rallying for 4 weeks. Sika AG (SIK, Financial) dropped 22% on Monday, 8 December, the Stoxx Europe 600 index dropped 0.7%, and the DAX index dropped 0.7%. For the Stoxx index, this was a surprise reversal given the 13% gain from the October slump through December 5.
Can the U.S. go it alone in a crumbling global economy?
The U.S. finds itself in an uncomfortable situation, since the fundamentals for growth are strong domestically but the global economy is in a shameful state. This begs the question: can the US prosper when the rest of the world is in dire straits? The Dow Jones was within 9 points of the magical 18,000 level on Friday, December 5, but the level was never breached. The decline in energy shares marks its lowest level in almost two years. Of the 10 sectors in the S&P 500, 60% of them fell on Monday. The shares of smaller companies were hardest hit, with 5% declines for Transocean (RIG, Financial), Climarex Energy and Noble Energy (NBL, Financial).
The markets were rocked by a 1.9 percentage point drop in Japan's economic growth between July and September (Q3), and anaemic growth in German industrial production which reported a growth rate of 0.2% for October. Combined, this news sent the oil price down 4 percentage points. The declines in the energy sector are bound to be met by increases in retail stocks such as Target (TGT, Financial), Walmart (WMT, Financial), Best Buy (BBY, Financial), Verizon (VZ, Financial), Costco (COST, Financial), Sears (SHLD, Financial), JC Penney (JCP) and others. Several pharmaceutical stocks rallied on the day, including Merck (MERCK) , Celgene Corp (CELGZ), Gilead Sciences (GILD) and Cubist Pharmaceuticals (CBST). Overall though Monday, 8 December slammed the brakes on the global economy as stocks slid and skidded before gaining some traction at the close of the day.
