Stocks & Oil – a new reality

Humans are creations of habits and quickly feel uncomfortable, when something – or someone – disrupts their habits.
For decades, the creature of the human stock-investor could be sure that ‘falling oil’ means ‘rising stocks’.

After all, we learned from dusty textbooks back at the university or private investment experience, that with cheaper oil:

• Private households and companies would save money.
• This savings would help the economy to grow via more private consumption that leads to higher earnings for companies.
• Companies itself would use the savings and higher earnings to invest more and grow, thereby creating new jobs and generate higher tax revenues for governments.
• Governments could use this higher than expected inflow of tax money not only for social issues but spend it for infrastructure-projects and create even more well paid jobs.

This should result in a broadly rising stock market, after all, the fundamentals (earnings) and the private investor’s mood (job-security in a growing economy) are both on the right track.
And because this scenario really took place in one way or the other for the last decades, many investors are more than puzzled, why their habit of ‘falling oil – rising stocks’ has been shattered by the last oil price decline in 2015/2016.

Is ‘sinking oil – sinking stocks’ the new reality? many ask. The correlation between the price of Brent-oil and the S&P 500 stock market index in 2016 is at 0.97 – the highest level in 26 years. A correlation of 1 would mean oil and stocks move by the same proportion in the same direction, a correlation of minus 1 would indicate a move proportionally in opposite direction.

Fact is that historically the correlation between oil and stocks has been tighter only in recessions – even during the financial crisis in 2008, it spiked just to 0.8, according to the ‘Wall Street Journal’.

Is there a reason to be afraid, that the current correlation indicates a deep global recession ahead?

Let’s have a look, what’s behind the new ‘low oil – low stocks’ reality:

• The crash of Opec’s production discipline has led to a oversupply of historic proportions.
• There is no end in sight, so not only oil-companies itself, but the whole oil-service industry is suffering. Big corporations like Schlumberger, Haliburton or Baker Hughes laid off tens of thousands of people in recent months. And they drastically cut investments that in turn affects the machinery industry dominated by Caterpillar.
• But there is more bad news. Bank-stocks are affected by the oil-slump as well because they financed the US-Shale Industry (the ‘frackers’) with billions. It’s estimated that up to 20% of these loans will not perform in this year alone given the low oil price.
• The producers in the Middle East have to cut their budgets – even Saudi Arabia – and started to sell shares, invested in markets around the globe by their huge sovereign-wealth-funds. 3 of the world’s biggest sovereign-wealth-funds (Abu Dhabi, Saudi Arabia and Kuwait) are owned by middle-east-oil producers and it’s estimated that they could sell shares for up to 400 billion USD, if oil prices remain in the range of 30 to 40 USD/barrel.
• In plus, the usually high demand out of this region for european goods – from machinery to highend luxury – is declining. Swiss company Richemont (it’s portfolio includes Cartier, Vacheron Constantin, Piaget or Montblanc) noticed massive lower sales to clients from the Middle East (as well a Russia and China) in the last months.

All these facts are ingredients for the new ‘low oil – low stocks’-reality. And from his mixture, at least the ‘low oil’ is here to stay. And it’s not only Opec or the slumping chinese economy, that will keep the oil price at bay for quite some time – the ‘new kid’ responsible for this outlook is playing in west.

The big influence on the oil price of the US-Fracking industry is tomorrow’s topic.

Oil and stocks go down hand in hand