Note to small-cap stock investors: it’s time to buckle up for a wild ride.

Recent weeks have been dominated by concerns around how the spread of COVID-19 will drag on economic growth and stock prices.

And now, those concerns have turned into capitulation. The ASX200 slumped by over 7 per cent to start the week, for a fall of 455.6 points — its largest one-day point drop of all time.

As coronavirus spreads, much uncertainty still abounds as to 1) just how deadly is and 2) how fast it’s spreading.

While that dynamic is in play, the outlook for economic growth will continue to slide. Westpac economist Bill Evans now expects Australia to fall into a technical recession in the first half of the year.

But out of nowhere, another negative catalyst emerged — an unexpected price war in global oil markets. Over the weekend, Russia surprised the market by saying it wouldn’t agree to any OPEC production cuts to help prop up prices.

Saudi Arabia — the world’s largest producer — responded aggressively; it too will ramp up production. As global oil demand slumps amid COVID-19, two of the world’s largest producers just agreed to ramp up supply.

The result? Oil prices promptly crashed by 30 per cent — an almost unprecedented fall that sent shockwaves through global markets.

To Mark Taylor, senior equities analyst at Morningstar (with a focus on oil & gas), conditions on the ground are about to get tough.

“All I’d say is that there’s going to be a swathe of global production that’s not economic at these prices,” he told Stockhead. “And an even larger portion that won’t be incentivised to grow or even sustain production.”

The ASX200 Energy Index crashed by 20 per cent yesterday, and a number of small-cap producers also felt the pain. The next question is, how long will the pain last?

“I don’t see (the oil price) being at those levels long-term,” Taylor said. “I don’t think the Saudis would be too happy leaving it there long term either. They’re sending a warning shot across the bows of what they consider some recalcitrants (Russia).”

Some in the market have also speculated that the move by Russia was part of an attempt to put pressure on high-cost US fracking producers. And Taylor said the industry now faces a serious threat.

“Fracking companies are higher cost producers, especially from a total return point of view,” Taylor said.

“And they are the swing producer, so the sweet spot for them is around $US60 a barrel. At those prices, they’re incentivised to keep investing but in an orderly manner — not going crazy. At $US25 a barrel, they’re going to be hurting.”

At the same time, cuts to US shale oil supply are likely to still take place with a lag effect.

“What generally happens when prices fall is that capex and investment gets cut, but they don’t normally curtail supply for quite some time, because the operating costs once you’ve drilled and are up and running aren’t that high,” Taylor said.

“It’s only when you get to the decision around drilling new wells.”

What happens next is the million dollar question, but regardless of the outcome Taylor doesn’t expect an overnight fix.

“I don’t know about (prices rebalancing) in the next few months, he says. These things could take longer to play out than that,” he said.

“It’s difficult to say — there could be a deal struck next week or it could be protracted and require some production to get curtailed through natural attrition.”

“But I doubt the Saudis will want to be giving oil away forever.”

Back on the ASX, gold stocks were more or less the only companies able to tread water amid a huge round of panic selling.

It comes as domestic governments at the state and federal level prepare to introduce stimulus packages to help spur economic activity.


‘Dream run’ hits a roadblock

For Dean Fergie, principal at Cyan Investment Management, the huge falls are partly a by-product of what’s been more or less a “dream run” for stocks over the past five years.

“I think the market’s needed an excuse to have a bit of a selloff,” he told Stockhead.

“So it was probably overdue. All I know is my experience, this time could be different, but markets can also rebound really quickly. But in the meantime there are plenty of people who are going to panic.”

Fergie said Cyan had actually been left out of some of the good times in the 2019 rally, after increasing its cash weighting as stocks rose.

And as prices came back to earth with a thud over the past two weeks, the fund has been making some conservative bets amid the broader revaluation.

“We’ve kind of been a bit wrong footed up until now, because we’ve held a lot of cash and we’ve arguably been wrong about that,” Fergie said.

“But from our point of view, it’s not a bad time to add a couple of selective positions now. You might lose again in the short term, but longer term prices will be due for a bit of a rebound because there’s so little return in asset classes elsewhere.”

However, this market is now a different beast — in what looks like the end of an 11-year bull run that was often marked by long periods of low volatility. Those days are gone for now.

“If you don’t have a high risk tolerance then you shouldn’t be anywhere near the stock market,” Fergie says. “People forget, it’s been going up and up for a long time.”

“You need to be a bit more measured about it. More prudent. Know that you’re operating in a volatile environment and the chances you’ll be very right or very wrong in a short pace of time are higher.”

“If you’ve got capital that’s prepared to take on a high level of risk, this does look like a bit of an opportunity to position the portfolio over the medium term, where there’s other asset classes that are making no return at all.”