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Covid-19 and oil price war: our views explained

Monday was a significant day for markets. For several weeks, both the world and investors have faced uncertainty as a result of the coronavirus. On top of this, we have seen a dispute among oil-producing countries come to the fore: the decision of Saudi Arabia to lower the price of crude oil over the weekend effectively triggered a price war. Though this could be seen as good news for families and companies in many sectors, from a financial point of view it is an additional element of uncertainty. In the short term, this has contributed to increased volatility in the financial markets this week.

In this kind of situation, it can be difficult to distinguish between the response to the social emergency and the medium-term impact on the real economy and financial markets. The biggest mistake an investor can make right now is to apply the logic of emergency precautions (such as those undertaken in Italy) – which are implemented to protect some of the most vulnerable in society – with the consequences for the economy. We think it is wise for investors to approach the coming months with a degree of emotional detachment, with the aim – particularly for those who have a long-term horizon – of maximising performance over time.

At this point it is difficult to predict the extent of the repercussions of recent events on the economy in the immediate future. Projections vary greatly, but the scenario that we see as the most likely is a gradual return to normal over the coming months. However, it is sensible to be cautious and to evaluate all possibilities, and we continue to monitor our model portfolios closely for all eventualities.

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What is certain is that politics, especially both monetary and fiscal policy (specifically that which is implemented by national and supranational governments), will likely play an important role. The United States is in an election year and President Trump has already announced his willingness to set up new tax incentives for businesses. Tomorrow, the UK government presents a budget that is rumoured to be generous, which could usher in a period of fiscal expansion. European governments and Brussels – although, admittedly with uncertain timeframes – are discussing coordinated measures.

From a purely financial perspective, we can expect volatility in the immediate future. However, once the fog of uncertainty begins to clear, an assessment of the pure economic situation will take place by markets. Importantly, history teaches us that financial markets start growing on the expectations of a return to growth – not waiting for actual economic growth itself.

It is for precisely this reason that remaining in markets is important for long term investors.  Missing the recovery in the markets can have a meaningful impact on performance (as outlined in our recent blog post here). Indeed, missing these periods can have a much bigger impact than the decline in equities we have seen in recent days. This is a key concept that must inform the choices investors make. It also guides our analysis. The time will come when opportunities may arise to increase exposure in various asset classes, including volatile ones (such as equities). Taking these opportunities is just as important to us as managing downside risk – this approach to adding value, in our opinion, helps to maximise our investors’ interests in the long term.

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