Oil Prices Will Determine Where The Stock Market Goes From Here
While the stock market continues to march higher, economic fundamentals continue to deteriorate. Forward-looking in nature, the stock market tends to discount (ignore) what is happening now in anticipation of what is to come over the next 6-9 months. Although top-down stimulus from central banks and governments have propped up financial markets, economic data points across the globe are signaling a prolonged downturn. For the first time in modern history (BP started keeping recording in 1861), WTI oil prices traded into negative territory reaching $-36.20 per barrel. In essence, storage facilities were giving away oil because they had no more room to store it. Oil markets have been telling us what is truly going on. But are investors listening?
Two weeks ago, OPEC+ decided to cut oil production by approximately 9.7 million barrels per day starting in May. Since that time, energy prices have been extremely volatile, falling further. Why did oil prices continue to fall despite the cut in supply? Lack of demand. Despite the fact that OPEC+ vowed to cut global supply by 10%, the gap between supply and demand has grown. Since the coronavirus accelerated, global demand for oil has fallen by 30%, leaving a 20% (20 million barrels per day) gap after accounting for OPEC+ cuts that start next month.
The lack of demand has been widespread. According to Rystad Energy AS and the Trafigura Group, energy demand is expected to fall by 28-35 million barrels per day. U.S. oil demand has fallen 30% to 14.4 million barrels a day, the lowest level going back to 1990. In its short-term outlook, the EIA forecasts the hit to oil demand will be 16.7 million barrels a day. According to country officials, India’s crude demand (third-biggest consumer) has collapsed by ~70% as the country endures the largest national lockdown. Canadian oil producers expect the gap between supply and demand to reach more than 1.1 million barrels a day in the second quarter. In Spain, oil product demand fell by 23% in March. With gasoline and road diesel falling by 35.5% and 26.5% respectively. In Italy, which together with Spain imposed some of Europe’s harshest restrictions on movement, retail fuel sales have plunged 85%.
The relationship between the S&P 500 and oil prices has strengthened over the last six weeks. The correlation (relationship) stood at .07 (statistically insignificant) in the middle of February, that figure now stands at .86 (statistically significant). Assuming there are no sizable policy stimulus that distorts prices further, I expect oil prices to dictate where the stock prices go from here. Oil price increases driven by short-term reductions in supply will not be enough. Globally, oil makes up 34% of our energy usage. Only an increase in demand will signal a genuine economic recovery. At some point, the stock market and economic fundamentals will need to be reconciled.
-Appo Agbamu, CFA
This material is for informational purposes only. Under no circumstances should any information or materials presented be used or construed as an offer to sell, or a solicitation of an offer to buy, any securities, financial instruments, investments, or other services. Any investment made is at your sole discretion. There are many factors that you must consider when making an investment decision, including, but not limited to, product features, risks, whether or not an investment meets your investment objectives, risk tolerance, and other personalized factors. Investing in securities involves risks, and there is always the potential of losing your entire investment.
Two weeks ago, OPEC+ decided to cut oil production by approximately 9.7 million barrels per day starting in May. Since that time, energy prices have been extremely volatile, falling further. Why did oil prices continue to fall despite the cut in supply? Lack of demand. Despite the fact that OPEC+ vowed to cut global supply by 10%, the gap between supply and demand has grown. Since the coronavirus accelerated, global demand for oil has fallen by 30%, leaving a 20% (20 million barrels per day) gap after accounting for OPEC+ cuts that start next month.
The lack of demand has been widespread. According to Rystad Energy AS and the Trafigura Group, energy demand is expected to fall by 28-35 million barrels per day. U.S. oil demand has fallen 30% to 14.4 million barrels a day, the lowest level going back to 1990. In its short-term outlook, the EIA forecasts the hit to oil demand will be 16.7 million barrels a day. According to country officials, India’s crude demand (third-biggest consumer) has collapsed by ~70% as the country endures the largest national lockdown. Canadian oil producers expect the gap between supply and demand to reach more than 1.1 million barrels a day in the second quarter. In Spain, oil product demand fell by 23% in March. With gasoline and road diesel falling by 35.5% and 26.5% respectively. In Italy, which together with Spain imposed some of Europe’s harshest restrictions on movement, retail fuel sales have plunged 85%.
The relationship between the S&P 500 and oil prices has strengthened over the last six weeks. The correlation (relationship) stood at .07 (statistically insignificant) in the middle of February, that figure now stands at .86 (statistically significant). Assuming there are no sizable policy stimulus that distorts prices further, I expect oil prices to dictate where the stock prices go from here. Oil price increases driven by short-term reductions in supply will not be enough. Globally, oil makes up 34% of our energy usage. Only an increase in demand will signal a genuine economic recovery. At some point, the stock market and economic fundamentals will need to be reconciled.
-Appo Agbamu, CFA
This material is for informational purposes only. Under no circumstances should any information or materials presented be used or construed as an offer to sell, or a solicitation of an offer to buy, any securities, financial instruments, investments, or other services. Any investment made is at your sole discretion. There are many factors that you must consider when making an investment decision, including, but not limited to, product features, risks, whether or not an investment meets your investment objectives, risk tolerance, and other personalized factors. Investing in securities involves risks, and there is always the potential of losing your entire investment.