By Brett Chatz

Extreme volatility now characterises global markets, with no end in sight!

It’s all about Crude Oil and China

Friday, 15 January 2016 proved to be a day Wall Street would rather forget, heading into the long weekend. The surprising downturn marked a strong reversal from the day before, when markets rallied. Of course, the reasons for the disappointing performance in major averages are already well known: plunging crude oil prices and weakness in China. The Shanghai Composite Index plunged 3.5% on the day, and since trading in Asia is completed before Wall Street opens, Wall Street had to absorb the losses.

By the end of the day, the Dow Jones industrial average was trading under 16,000, at 15,922 points. That marked a loss of 2.8% on the day. Other major averages also closed sharply lower, including the NASDAQ composite index which was trading at 4,452, for a decline of 3.5%. The S&P 500 index also plunged 3%, and closed the day at 1,865. Traders across the board were shaking their heads in dismay, uncertain where the markets were headed next.

Why is oil price weakness impacting Wall Street so heavily?

There is a difference between the effects of cheap oil on everyday consumers and the effects of cheap oil on major averages. For starters, Wall Street comprises all the listed companies that are trading in various sectors. Energy companies (oil and natural gas) such as Exxon Mobil Corporation and BP have been hit hard by plunging oil prices. It’s clear to see why low oil prices are bad for business: declining revenues, declining profitability and declining demand. Add to that real concerns that Iran will soon start pumping 500,000 barrels of oil per day and dumping it on to global markets.

Iran’s reentry is one of the most pressing concerns in an oversaturated commodities market where weakness in China has impacted on the performance of emerging market countries the world over. China’s once insatiable appetite for crude oil, natural gas, copper, iron ore and the like has waned and this is clearly evident in the mass layoffs, shutterings and declining profitability of major multinational energy and metals companies. There are many such examples of companies that are closing down unprofitable business operations, with mass layoffs taking place. Anglo American, Rio Tinto, BHP Billiton and Glencore plc are cases in point.

Sharp Losses Recorded in January

The S&P 500 financial sector is performing below par, with regional banks losing 12.3%, investment banks and brokerages losing 16.1%, diversified banks losing 13.1%, consumer finance dropping 10.5%, asset management and custody banks dropping 13.5% and the financial sector sliding 10.3%. The weakness is all pervasive, and that is why such bearish speculative sentiment has gripped the markets. This is more than a new market correction that we are looking at – it could well be a global economy on the cusp of another recession. We know for instance that Russia is hugely dependent on energy such as oil and natural gas for its survival, and prices at current levels are destroying the Russian economy and the Russian ruble. Much the same is true for countries like Nigeria, Venezuela, Libya and others.

The current oil price rout will lead to widespread economic weakness on an unprecedented scale unless OPEC and/or WTI crude oil producers agree to cut production so that prices can start rising and profitability can be restored. However that decision is unlikely to be made until such time as OPEC is confident that it has forced enough shale oil producers out of the market. There is a parallel problem taking place and that is the issue of a strong US dollar. Since oil is a dollar-denominated asset, demand will be weak when the dollar is too strong. Emerging market currencies are suffering immeasurably under the burden of a strong dollar and weakness from China. The confluence of all these factors is having a crushing effect on the global economy and it’s only a matter of time before something gives.

Author Bio: Brett Chatz is a graduate of the University of South Africa, and holds a Bachelor of Commerce degree, with Economics and Strategic management as his major subjects. Nowadays Brett contributes from his vast expertise for the globally renowned spread betting company –InterTrader.