Worldwide stock indexes experienced mixed fortunes on Tuesday, with some investors cheered by the Chinese economy’s apparent return to growth after a month spent battling the COVID-19 outbreak.
Among the indexes showing mild signs of recovery were the FTSE-100, which was up by 0.8% on Tuesday morning.
Other European stocks wobbled, with France’s CAC 40 seeing a 1% slide while Germany’s DAX was 0.6% down.
Despite the FTSE’s uptick, the London index remains roughly 26% down from its standing at the start of the year, having seen a mass sell-off following 9 March (colloquially known as “Black Monday”).
Showing greater optimism were Asian indexes, with Japan’s Nikkei rising by 0.9% and South Korea’s KOSPI Composite Index closing after a 2.2% net increase.
These gains follow the overnight release of China’s Purchasing Manager’s Index (PMI) for March as 52.0, an unexpectedly good showing for the nation’s economy after much of its production was put on hold during the month.
It is worth acknowledging, however, that a recovering stock market does not necessarily equate to a recovering economy. Also on Tuesday, the World Bank warned that 11 million people in East Asian countries, including China, are likely to face poverty as a result of economic downturn.
“Countries must take action now – including urgent investments in healthcare capacity and targeted fiscal measures – to mitigate some of the immediate impacts,” the World Bank said in a press release.
The so-called ‘resource curse’ has reduced a once prosperous nation into a financial meltdown. The increased social and economic upheaval has sparked protests on a nationwide level and led many poor people to lose faith and withdraw their allegiance to President Nicolás Maduro. Amidst the political and economic turmoil, the EU, the US and a number of other countries across the globe have recognised opposition leader Juan Guaidó as the South American nation’s rightful interim president. In a bid to alleviate “the poverty and the starvation and the humanitarian crisis” currently gripping Venezuela and stop “Maduro and his cronies” looting the assets of the country’s people, US President Donald Trump has announced sanctions against Venezuela’s state-owned oil company PDVSA. US National Security Adviser John Bolton announced that the measure will “block about $7 billion in assets and would result in more than $11 billion in lost assets over the next year”. Effective from 29th January, the sanctions guarantee that any purchases of Venezuelan oil from US entities flow into blocked accounts and are supposed to be released only to the country’s legitimate leaders.
The situation in Venezuela has puzzled social scientists for years. On paper, oil-exporting countries and their economies are supposed to be thriving. Why is this not the case for Venezuela and what does the ‘resource curse’ have to do with it?
The Oil Curse Explained
The resource curse is a concept that a number of political scientists, sociologists and economists use to explain the deleterious economic effects of a government’s overreliance on revenue from natural resources.
In Venezuela’s case, being overconfident in its status as an oil powerhouse, the country’s socialist government became so dependent on oil production that it managed to lose track of its food production. Farms and other similar industries were expropriated by the government, which combined with the lack of private ownership due to the country’s socialist regime, led to a massive decrease in food production. Crop farmers weren’t able to acquire pesticides from now-government owned chemical companies, animal farmers weren’t able to acquire feed from crop farmers and food depleted. Nationalising businesses meant that business owners were forced to stop food production, while the government ignored food production altogether due to its full reliance on oil riches, which became the main focus.
As with any commodity, stock or bond, though, the laws of supply and demand cause oil prices to change. In 2014 for example, when oil prices were high, Venezuela’s GDP per capita was equivalent to 13,750 USD, while a year later, due to a dip in oil prices, it had fallen 7%.
This example perfectly illustrates the resource curse concept. A country, in most cases an autocratic country, becomes so dependent on a single natural resource that it disregards all other industries. The government is happy because the revenue is enough to feed them and secure their position of power. Naturally though, over time all other branches of the economy slow down to the point when the commodity prices inevitably drop, the country’s economy is not equipped for survival. According to the concept, the resource curse is an issue seen in the Middle East, however, it has never been so clearly displayed as it is now in Venezuela.
US Sanctions & their Impact
As mentioned, the oil industry is the main sector that is responsible for Venezuelan government’s revenues - for more than 90% of revenues to be precise. Before delving into the way the sanctions are expected to affect the country’s economy, let’s take a look at the country’s oil production stats. According to data from Rystad Energy, in 2013, Venezuela was producing 2.42 million barrels per day, while the output today is lingering above the 1 million mark. Production has been dropping more intensely in recent months and even without the recent US sanctions, the oil production in the country would have experienced a drastic drop due to lack of investment. Trump’s administration’s restrictions are only rubbing salt into the wound.
Even though the White House’s intention is to make oil revenues reach the people of Venezuela and bypass Maduro’s government, which owns most of the oil industry through PDVSA, the sanctions have the power to be disastrous for the country’s economy and potentially set off a domino effect in the global energy market. Two things are worth mentioning here: Venezuela used to be the fourth biggest crude importer in the US (after Canada, Saudi Arabia and Mexico), while the US is Venezuela’s number one customer. Thus, the problems that arise from the sanctions are that A) US Gulf Coast refineries are frantically looking for alternate sources for the crude oil that Venezuela has been providing them with up until now and B) Venezuela, on the other hand, is struggling to find new customers. On top of this, the US was Venezuela’s key source of naphtha, which is the hydrocarbon mixture used for diluting crude. Without it, PDVSA won’t be able to prepare its crude oil for export. Rystad Energy forecasts that some operators in Venezuela will run out of the crucial diluent by March.
However, not all hope is gone. Paola Rodriguez-Masiu from Rystad Energy believes that the impact of the sanctions will be significantly lower than Washington has predicted and says that: "The oil that Venezuela currently exports to the US will be diverted to other countries and sold at lower prices. For countries like China and India, the news was akin to Black Monday. They will be able to pick up these oil volumes at great discounts." She adds that Venezuela exports 450,000 barrels of oil per day to the US – a little under half of its total output and the amount of new oil which will flood the markets. Mrs Rodriguez-Masiu also mentions that so far, oil markets have massively shrugged off this new oversupply as investors have been pricing in the crisis in Venezuela for quite a long time.
So now what?
Although Venezuela is still seen as an oil powerhouse, especially due to its production of heavy crude (which is not widely available in the world), the oil world is expecting the historic collapse of its oil output to only intensify. The country needs to offset the effects of the US sanctions, find new financing and not let the people of Venezuela bear the brunt.
This will not be easy though. As the government desperately courts new buyers for its oil, it may find them hard to come by, with Chinese sales in a pattern of decline and new markets such as India worried about quality and transport issues due to much of Venezuela’s shipping designed for shorter distance travel. Indeed the government and prospective buyers will only be too aware that it is always harder to negotiate from a position of weakness.
Unfortunately for the people of Venezuela who are struggling to get basic supplies, and are facing starvation and illness, the actions and the effects of the country’s government and the oil curse look set to reverberate for some time.
Sources: https://www.thetimes.co.uk/article/venezuela-frustrated-poor-losing-faith-in-beleaguered-maduro-22cf7f66z https://edition.cnn.com/2019/02/04/americas/europe-guaido-venezuela-president-intl/index.html https://edition.cnn.com/2019/01/28/politics/us-sanctions-venezuelan-oil-company/index.html https://www.investopedia.com/terms/r/resource-curse.asp https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=IVE0000004&f=A https://www.forbes.com/sites/ellenrwald/2017/05/16/venezuelas-melt-down-explained-by-the-oil-curse/#39dcb3d0282b https://www.ogj.com/articles/2019/02/rystad-energy-venezuela-production-could-fall-below-700-000-b-d-by-2020.html https://www.bbc.co.uk/news/world-latin-america-47104508
19th October marks the 30th anniversary of Black Monday, when in October 1987 stock markets around the world experienced a flash crash. The FTSE 100 fell 11% on the day, and then fell a further 12% the next day, wiping out more than a fifth of the value of the UK stock market in just two trading sessions.
As terrifying as these sharp falls were, hindsight tells us that for investors who didn’t panic, even a badly timed investment made money in the long run.
Laith Khalaf, Senior Analyst, Hargreaves Lansdown: “Stock market crashes are a bit like the Spanish Inquisition- no-one expects them. The 1987 crash is renowned for the speed and severity of the market decline, and undoubtedly when markets are plunging so sharply, it’s hard to keep a cool head.
“Hindsight clearly shows that the best strategy in these scenarios is to sit tight and not engage in panic selling. Time has a tremendous healing power when it comes to the stock market, and price falls are typically a buying opportunity. The stock market is an unusual trading venue, in that buyers tend to stay away when there’s a sale on.
“The Footsie has recently reached a new record high, which prompts the question of whether it’s heading for a fall. There are always reasons to worry about the stock market and now is no exception. The Chinese credit bubble is front and centre of concern, along with increasing global protectionism, and the disturbing prospect of World War Three being started on Twitter.
“However there are also reasons to be positive, with the global economy moving up a gear, borrowing costs remaining low, and stocks facing little competition from bonds and cash when it comes to offering a decent return.
“The market will of course take a tumble at some point, and it’s impossible to predict when. This makes being bearish an easy game, because you only have to wait so long before you are eventually proved right. The big question though, is how much you have lost out on in the meantime by sitting on your hands.
“It’s important to bear in mind that investing isn’t a one-time deal, savers typically invest at different times throughout their lives, and at different market levels, and sometimes they will be luckier with their timing than at others. To this end, a monthly savings plan takes the sting out of any market falls by buying shares at lower prices when the inevitable happens.
“The golden rule, of course, is to make sure you are investing money for the long term. In the short term the stock market is a capricious beast and can move sharply in either direction, but in the long run, it’s surprisingly consistent.”
After the crash
The table below shows stock market returns following the three big stock market falls of the last thirty years: 1987, 1999-2003 and 2007-2009.
The first column shows what you would have got by investing £10,000 on the eve of the crash, and pulling your money out at the bottom of the market. The remaining columns show what would have happened to your investment if you had held on to it. These numbers should be viewed as examples of what stock market returns have been if your timing is really pretty stinky, and you only happen to invest £10k once in your entire life, on the eve of a dramatic downdraft in the market.
In 1987 investors would have seen £10,000 reduced to £6,610 in a matter of weeks. However, if they had waited 5 years, their investment would have fully recovered, and 10 years later would be worth £32,690, with dividends reinvested. Today that investment would be worth £104,340.
Stock prices recovered pretty promptly after the 1987 crash, in contrast to the bursting of the tech bubble in 1999, which was compounded by the Enron scandal and the World Trade Centre attack, leading to a deep and prolonged bear market lasting until 2003. £10k invested in the stock market in 1999 would be worth £23,210 today, an annualised return of just over 5%.
Looking at these figures, it’s hard to dodge the conclusion that this was the worst of all three periods for stock market investors. It also contributed to the already declining fortunes of defined benefit schemes in the UK, and did huge reputational damage to insurance companies as the dreaded MVR (Market Value Reduction) became common parlance amongst hitherto happy With Profits policyholders.
The value of rolling up dividends shines through in the numbers below. Since the peak of the market in June 2007, £10,000 would only have grown to £11,890 based on stock price movements alone. But once dividends are counted and reinvested, that rises to £17,230, not a bad result given this money was invested at the peak of the market just before the global financial crisis took hold.
Is the Footsie about to crash?
The FTSE 100 reaching a new record high recently has of course prompted questions about whether it’s heading for a fall. However the level of the Footsie is not a measure of the value in UK stocks, seeing as it doesn’t take account of the level of earnings of companies in the index.
Below are two related measures of value of the UK stock market which take company earnings into account, but each give a slightly different picture of valuations in the UK stock market right now.
The headline historic P/E is elevated compared to its historic average, though still well short of the level seen in 1999.
The Cyclically Adjusted P/E Ratio, a valuation method championed by Nobel prize-winning economist Robert Shiller, takes a longer term view of earnings by looking over the last 10 year, which smooths out volatility in the one year P/E number.
On the cyclically adjusted measure, the UK stock market is trading below its historical average, and well below levels seen in both 1987 and 1999.
So which of these two measures should we believe? Well, we assign more weight to the Cyclically Adjusted P/E because it takes a longer term, more rounded view of stock market valuation. But if we simply take both measures into account in combination, together they suggest the market is somewhere in the middle of its historic range.
When thinking about the valuation of the stock market, it’s also worthwhile considering the valuation of alternative assets. The 10-year gilt is currently yielding 1.3%, and cash is yielding next to nothing with base rate at 0.25%. This contrasts sharply with 1987 when base rate was 9.9% and the 10-year gilt was yielding around 10%. So if you think the UK stock market’s expensive right now, then you have to take a really dim view of the value provided by bonds and cash.
(Source: Hargreaves Lansdown)
Today marks the 30th anniversary of the day when the financial bubble, that resulted in the Dow Jones reaching a record peak of 2722 in August, burst in spectacular fashion.
Following a fraught Friday on the New York Stock Exchange where the DJIA dropped sharply, the opening bell on 19th October started a selling onslaught and panic on the floor that hasn't been seen since. We take a look back at Black Monday 1987 in numbers.
Black Monday In Numbers
"It was a frightening week, more frightening than any week in '08" - Jim Chanos
19th October 1987 – The date of Black Monday.
9am – The sounding of the opening bell that began the selling that almost crashed the entire American financial system.
250 points – Points drop on the Dow Jones by 12:30pm.
508.32 points – Number the DJIA fell on 19th October 1987, it was at the time the largest drop Wall Street had seen.
4x – The amount the points drop on 19th October was bigger than the previous record.
22.76% - One Day Percentage Loss on the Dow Jones Industrial Average (DJIA). A record that still stands today.
Dow Jones Industrial Average from January - December 1987
$500 Billion – Amount of capital lost on 19th October 1987.
33% - Drop in S&P Futures on Black Monday.
604.33 million shares – Volume of shares on the New York Stock Exchange. A record at the time.
$1 Billion dollars – Value of Sell Orders reached by 10am on 19th October.
112 million – Shares lost by the Designated Order Turnaround System at NYSE as the computers buckled under the weight of sell orders.
648 - Days it took for the markets to recover.
$18.8 Billion - Market Value Lost By IBM on Black Monday. It was valued at around $62 Billion before Monday 19th October.
"Wall Street was uniformly unprepared for this magnitude of drop" - Paul Tudor Jones, October 19th 1987
23pc - Drop on the FTSE 100 on Black Monday and Tuesday combined. The biggest ever in history and a figure that has never been seen since.
60% - Percentage drop of the New Zealand Stock Market after Black Monday.
$6.7 Billion - Total in paper losses on AT&T Shares.
30.9% - Amount of American Express shares were reduced by during the trading day.
Traders react after one of the worst days the New York Stock Exchange has ever seen.
33 – Age of Paul Tudor Jones in 1987, when he and his colleague Peter Borish foresaw Black Monday.
$100 Million - Amount Paul Tudor Jones made by shorting the market and ensured his legacy on Wall Street.
$1 Billion – Amount Sam Walton, reportedly America’s Wealthiest Man lost on the day. ''It was paper when we started, and it's paper afterward.'' He said after the days trading.
$500 Million - Reported figure that Walton's Wal-Mart company value lost on Black Monday.
40% - Reduction in restaurant bookings and turnover in local businesses used by Wall Street Traders on 19th October.
$500 Million -Reported value of holdings in Allegis, Holiday, Bally and various other companies sold by future President Donald Trump in August that ensured he avoided any losses and became one of the few to make money on Black Monday.
16 hours – The time it took after the Dow Jones Closed on Black Monday for the US Federal Reserve to release a statement saying that it “affirmed today its readiness to serve as a source of liquidity to support the economic and financial system”
10 – Number of the largest banks who extended credit to traders following the Federal Reserve statement.
Traders stand bewildered after the New York Stock Exchange closed on Black Monday
2,078 – Stocks Traded on the board at the NYSE on Black Monday.
2,038 - Stocks Traded on the board at the NYSE that made a loss.
$470 – Amount Gold price per ounce increased (from $15.50) as one of the only performing stocks.
$1 Trillion – Total loss of wealth by the close of play.
$10,000 – Cash withdrawn late on 19th October from his Bank by Allan Rogers, head of government bond trading at Banker’s Trust, and hid in his loft because he was so scared the whole banking system was going down.
7% - Percentage of stocks that didn’t even open the following morning.
126 points – Rise in DJIA in the opening minutes of Tuesday 20th trading following Federal Reserve stop-gap measures.
10:00am – The rally is over and the Dow Begins to plummet once more.
11:28am – Time the Chicago Mercantile Exchange ceases trading on the S&P contract.
The crash was splashed all over the world news following a devastating day for traders.
11:15am – Time on Tuesday 20th October traders and banks like Merrill Lynch, Goldman Sachs and Salomon requested John Phelan CEO of the NYSE perform a total shutdown due to lack of buyers.
285 – Price paid by Blair Hull on MMI Futures in Chicago sparking the rally that some say prevented a full blown crash.
62% - Amount made by Tudor Investment Corp. in October.
102.27 – Dow Jones Industrial Average gain on the day for Tuesday 20th October.
23000 - Number hit by the Dow Jones on October 18th 2017, almost 30 years on from Black Monday sparking fears another equity bubble may be about to burst.
Thanks to some quick responses from the Federal Reserve and a surprise market rally, the Dow Jones rallied enough to avoid a repeat of the Great Depression that had followed the Wall Street Crash of 1929 that bore many similarities to Black Monday in 1987.
The flash crash also led to several huge changes on Wall Street including a kill-switch on trading the S&P if it drops below 7% and an overhaul of the computer systems that had caused so many issues on that fateful day to ensure that the confusion and inability to trade would no longer be an issue. And while there have been monumental crashes on trading floors across the world, none seemed to repeat the speed and fear that occurred on the New York Stock Exchange on the 19th October 1987.
Rumour and conjecture abound in the financial world that lessons may in fact not have been learned, and that we may be in line for another Black Monday, especially given the DJIA topping the 23000 figure just today. Analysts remain nervous, citing an 8-year bull market and reports of a hugely over-inflated US stock market. One thing is for certain, no one at the New York Stock Exchange will want to see the markets offer up any sort of anniversary.
