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S&P 500 closes modestly lower as oil prices crater

We live in a very risky world and investors should not get “carried away” with excessive allocations to equities, or for that matter, real estate. As always, asset allocation and low cost and broad diversification will be essential in earning one’s fair share of whatever returns our financial markets are generous enough to bestow upon us. – John Bogle

Despite no shortage of negative news last week related to the economy, oil prices, quarterly earnings and the coronavirus, the S&P 500 Index managed to close only modestly lower while the Nasdaq Composite Index was virtually flat. As far as the economic data were concerned, the weekly jobless claims painted a bleak picture again as 4.4 million people filed, bringing the 5-week total to more than 26 million and erasing all of the job gains since the Great Recession. Oil prices also cratered as the futures contract for West Texas Intermediate crude briefly went negative on Monday before rebounding and ending the week at $17 a barrel. Weak global demand coupled with a worldwide glut of oil as created massive storage capacity problems, meaning that if you owned oil last week, you literally had to pay someone to take it off your hands. The situation has become so dire that the Trump administration is looking for ways to support U.S. oil producers as many companies may be forced to file for bankruptcy protection. With the exception of Netflix, which beat earnings estimates as the company blew away new subscriber expectations, first quarter earnings results were inconsistent and are expected to decline by 15%. Companies in the technology, health care and consumer non-durables sectors are likely to fare better as opposed to companies whose fortunes are tied to the health of the U.S. economy and are more cyclical in nature. The spread of the coronavirus also continued to take its toll last week as the number of Covid-19 deaths in the U.S. passed 50,000 even as the number began falling in hot spots like New York. To be sure, there were some bright spots in an otherwise gloomy week. Although the World Health Organization (WHO) reported disappointing results from a trial of Gilead Sciences’ remdesivir, a potential treatment for Covid-19, the company took issue with the report and said that data showed the drug is effective with patients who are treated early with the disease. The Senate also finally approved a deal for a $484 billion relief package for small businesses, hospitals and further testing.

Last Week

Existing home sales plunged in March due to the coronavirus outbreak and the data is likely to get worse in subsequent months. U.S. durable goods orders dropped a worse-than-expected 14% in March but orders for non-defense capital goods, a reliable measure of business spending, edged slightly higher. But the modest gain is not sustainable amid the coronavirus pandemic.

For the week, the Dow Jones Industrial Average dropped 1.9% to close at 23,775 while the S&P 500 Index fell 1.3% to close at 2,836. The Nasdaq Composite Index slipped 0.2% to close at 8,634.

This Week

The preliminary estimate for first quarter gross domestic product (GDP) is a contraction of 4%, compared to a 2.1% growth rate in the fourth quarter of 2019. The April ISM manufacturing index is expected to fall to a reading of just 36 from 48 in March. Any reading below 50 indicates contraction. Consumer confidence in April is also expected to plunge from a level of 120 in March all the way down to 85 as job losses reach Depression-era levels.

Among the most notable companies scheduled to report quarterly earnings this week are 3M, Caterpillar, Ford Motor, Boeing, General Electric, Honeywell, Advanced Micro Devices, Alphabet (Google), Automatic Data Processing, Facebook, Microsoft, Amazon, Apple, Merck, Pfizer, Pepsico, Starbucks, McDonald’s, Mastercard, Comcast, UPS, Chevron, Exxon Mobil and ConocoPhillips.

Portfolio Strategy

Technologies that have enabled energy companies to extract oil from shale have made the U.S. the top oil producer in the world and have led to our energy independence. But the fact that oil futures were briefly negative last week and ended the week at only $17 a barrel provided a wake-up call to the industry. The problems began when Saudi Arabia and Russia failed to agree on production cuts as the coronavirus pandemic began to spread and Saudi Arabia proceeded to reduce the selling price and increase production. Even though these actions brought Russia back to the bargaining table and the two sides agreed on production cuts of 10 million barrels a day, the damage had already been done. The supply of oil continues to outpace the demand as economies worldwide have slowed dramatically or have shut down altogether due to the coronavirus pandemic. This creates a major problem for smaller oil producers in the U.S. who need at least $20 a barrel to cover their costs and $40 a barrel to make a profit. Many of these companies will be forced to cut back on production and will face an uncertain future unless oil prices stabilize at much higher prices. While they may be able to weather the storm over the near-term, smaller producers could fall victim to mergers and bankruptcy longer-term if the current situation doesn’t improve. For investors, it’s prudent to be defensive by sticking with the largest integrated oil companies that have strong balance sheets. Three companies that fit this description and have above-average dividend yields are Chevron (5.9% yield), Exxon Mobil (8.0% yield) and ConocoPhillips (4.7% yield). While there is a strong possibility that Exxon Mobil may cut its dividend, the other two companies offer dividends that appear safe. These stocks could go lower over the near-term given the uncertainties in the industry, but patient investors should be rewarded over the longer-term.