Why extreme oil price volatility sets off alarm bells for markets and the economy
Nearly every time front-month Brent futures have risen or fallen 30% or more in a month, that’s been accompanied by above-average stock market volatility. In most cases, it’s either coincided with or been soon followed by a recession.
In the long run, stocks tend to follow earnings.
And in the short term, RBC’s equity analysts don’t think the companies they cover (outside of the energy sector) will take a big hit from the increase in oil prices.
RBC’s analysts were polled on March 3 and 4 on what would happen in the event that this conflict lasts more than four weeks with crude prices staying above $100 for “an extended period of time.”
Their response, per RBC Chief US Equity Market Strategist Lori Calvasina:
“Among our non-Energy analysts, 72% said that EPS impacts from higher oil and gas would be ‘none,’ ‘only a little,’ or ‘not relevant/mixed/don’t know.’ The same was true for 77% of our analysts when we asked about direct revenue / Middle East impact and 66% when we asked about impact from knock-on effects. Does this data suggest that a worsening of the conflict doesn’t matter to US equities? No, but it does suggest that the risks are concentrated in certain areas and that in many the potential impacts are not seen as highly significant.”
That’s a rather glass-half-full way of approaching the current backdrop for markets (but, to be fair, the glass-half-full view usually carries the day for stocks).
History would also tell us that extreme moves in oil prices tend to either reflect, or cause, big changes in demand. That is, oil going down a lot tells us that demand is bad; oil going up a ton tells us that demand will soon be bad because of how high prices are.
Outside of crude rebounding from a supply-driven tumble in Q1 2016, every time front-month Brent futures have risen or fallen 30% or more in a month, that’s been accompanied by above-average stock market volatility. In most cases, it’s either coincided with or been soon followed by a recession.
Because oil plays a role in determining the price of everything that’s shipped, as well as how much most people spend filling up their tanks, it has a big macroeconomic impact.
Whether or not an individual company will face stress from surging oil prices is missing the forest for the trees — or rather, missing the tankers for the empty strait.
Oil price volatility is something that tends to mark a crisis. What’s happening right now is certainly a geopolitical crisis, and could metastasize into an economic and market crisis. It certainly doesn’t have to! But one thing we know about humungous gyrations in oil prices is that they’re fuel for higher correlations, and in times of crisis, correlations tend to go to one.
