This past week has been a rough experience for a lot of investors as global markets have declined mainly due to oil prices continuing to fall and indications of a Chinese slowdown on the horizon potentially having global implications. At the time of this writing the S&P/TSX Composite index was down 4.5% and the S&P 500 index was down 3% over the week, as the price of oil has slid by over 12%.
Source: Yahoo Finance
But is this really a cause for worry?
As we know markets generally react to significant moves in any one specific area – Oil, in this case, which has sunk below $60 a barrel, the lowest in over 5 years on account of weaker expected demand with an oversupply in the market. So how would this impact the various sectors of the economy? Clearly the Energy sector has been significantly impacted due to the price of the oil dropping, but why have other sectors declined, when lower oil prices could potentially improve profit margins?
In the short term, markets do take time to adjust itself to new information. What we are seeing today, we believe, is a combination of an initial reaction to the sudden drop in oil prices and profit taking, considering that most market indices are still up year to date.
As long term investors, we need to keep our focus on the fundamentals – stock prices are mainly driven by corporate earnings, which have continued to perform well. Although many companies in the S&P 500 Index have revised their earnings estimates down for Q4 2014, we should continue to see overall positive performance going in to 2015 and beyond as economic conditions continue to improve, although at a moderate pace, and central banks in major economies stand ready to support growth by providing monetary stimulus. If energy prices remain low in the long term, it should help corporates reduce their costs and improve margins, while leaving more money in the consumer pockets for spending. All of these factors should support stock prices and provide healthy returns, looking forward.
For long term investors, we simply need to step back, look beyond the current events leading to market decline and continue to hold a well-diversified portfolio across various sectors of the economy and markets around the world. If you have money on the sidelines, this may be a good time to put it to work as the single largest risk that investors face is being left out when markets rally sharply as we have seen in the past.
We believe the dust will settle soon!