The price of oil and the influence oil has had on the perception of risk in the stock market has been tangible, but we believe those days are numbered, and may actually already be behind We believe oil and the stock market are very likely to move to the beat of a different drum in the months ahead.
When markets fall, investors love to point the finger at something. For example, we may have heard “it was because of oil or Apple or China” recently, and, sure, those were all factors, but healthy markets can often withstand events like that. Ours is currently not one of those markets.
As stated, the focus of this piece is on oil, specifically the impact oil price declines have seemingly had on the market. While there is a technical parallel, we insist that they were not in tandem under the surface; oil was falling for one reason, and the market was falling for another.
The price of oil fell due to supply concerns and less demand from China. OPEC’s stance was also a direct influence on the decline. The decline happened at the same time valuation risks in the market were sky high after the market failed to rally at the end of the year and broke a historical cycle of being up in the third year of a second presidential term. After margin debt was also pushed to all-time highs and the cash-to-margin debt ratio depleted to all-time lows. Now something may be changing.
Although nothing is official, we are all privy to information that now suggests Russia and OPEC engaged in talks in February, and the purpose was to cut production by 5%. Doing this, would translate into a two-million-barrel-per-day reduction, which would turn the tides on the supply problem.
Estimates suggest that about 1.5 million barrels in excess are produced daily at this time. The meeting between Russia and OPEC is considered an emergency meeting. In the months following past emergency meetings, the price of oil surged. That suggests the same could happen again, but we believe it would be much more than that, too; current oil prices could triple over the next 12 to 18 months.
“However, in consideration of the market, our outlook is that the risk of a market crash remains real, too. This will be true regardless of what happens to oil, and especially if oil prices increase because of changes to the supply alone without any economic improvements that might improve demand.” said Seth Quansah a Market Risk Analyst.
In that light, the risks in the market would stay while oil prices moved up. In fact, risks could actually increase if gasoline prices spike along with oil prices and the consumer starts pulling back in a much more material way.
That is exactly what we expect, and the tail (oil prices) will stop wagging the dog (the market), and it probably already has, but then again, it probably never was.
“Certainly, there will be some continued correlations that are normal, but we will be able to observe material divergences in chart patterns soon.’ Seth added.