While using www.vetr.com earlier today, we noticed that oil was down while the rest of the market was more or less universally up. Today was the first time in several sessions that these two went in opposite directions , and it got us thinking about the popular claim that a dropping oil price was a negative indicator for equity markets. Is it really justified to sell stocks just based on a falling oil price?
On the face of it, the market has seemed to think so. The steep decline in oil that started a few weeks ago has been blamed for sparking the recent correction in the equity market. But taking a more macro view, a lower oil price is generally considered to be a good thing for the broader economy, as everything from manufacturing inputs to transportation costs go down. It may not be the harbinger of doom many seem to believe.
Some analysts have been quick to point out that slumping oil prices could mean slumping demand, suggesting the global economy is slowing down. But this assertion is not borne out by facts – nominal GDP growth in the U.S., Europe, China and Japan is solidly positive, and economic fundamentals, including interest rates and inflation, remain supportive. Supply, on the other hand, has increased as U.S. shale has entered the market in size, and a rising U.S. dollar has pressured the price.
On the contrary, oil bear markets seem to be positive for stocks. Although oil is down nearly 30% since September of last year, stocks (as measured by the S&P 500) are up nearly 20% – including the dip of the past few weeks. And historically, a decline in oil bodes does not necessarily bode ill for the stock market – surveying 26 bear markets in oil since 1990, stocks rose through roughly 65% of them.
And leaving the broader market aside, what about oil stocks? Unsurprisingly, bear markets in crude often contain the seeds of their own reversals, as the lower price spurs economic activity, which, in turn, spurs greater demand for oil. A few quarters down the road, oil stocks tend to put up comparatively good numbers. This has created a healthy debate about where oil and oil-service stocks are headed.
What do you think? Are $SLB, $HAL, $CVX, $XON, $BHI, etc. oversold and destined to be significantly higher down the road, or does the falling oil price mean they have further pain in store for their investors? Rate them!
Disclosure: At the time of this writing, Vetr had no position in the equities mentioned in this report.