What stocks to invest in = the weird relationship between stocks and oil « PRACTICAL STOCK INVESTING



What stocks to invest in

Over the past several months, there’s been a strong correlation between the movement of the crude oil price with the movement of stock prices around the world.  Oil goes up, stocks go up; oil goes down, stocks go down.

Until last week, there has been a certain logic to the link–a logic I think is incorrect, but a logic nonetheless.  Traders seem to be observing, correctly, that when economic activity is weak the demand for oil declines, both because consumers economize and industry uses less.  When that happens, the price of oil falls.  Therefore, traders say (incorrectly), the sharp drop in the oil price over the past 20 months is evidence that the world economy must be weaker than we think.  So low oil price = sell, or short, stocks.

 

Two problems with this line of thought:

–this is a little pedantic (actually, just skip over this paragraph), but logically “weak economy ⇒ falling oil price” doesn’t imply the converse, “falling oil ⇒ weak economy”.  It implies “not weak economy ⇒ not falling oil price.”  It’s like if you’re standing out in the rain, you get wet.  But if you’re wet, it doesn’t mean you’ve been standing out in the rain.  You may have been taking a shower.  Put a clearer way, the fact that a falling oil price is a symptom of economic weakness doesn’t mean it causes it.


–global demand for oil is, in fact, rising, not falling, according to the International Energy Agency.

 

Nevertheless, whether it makes sense or not to me, oil and stocks have been going up and down in lockstep.  So it makes sense to someone else–actually, a lot of someone elses.  And, like when it makes no sense but you see the train is barreling down the track at you, the best course of action is to step off the rails and out of the way.

That’s not the real weirdness.  Here’s where that comes in:

Over the past few days, oil and stocks have been going up on the rumor that a number of big oil producers, including OPEC and Russia, are talking about cutting back their production in order to prop up prices.

This would obviously be good for them.  If they’re getting $30 a barrel now and can move the price to $40 by reducing output by, say, 10%, their revenue goes up by 20%.  If the price got to $50, they’d be 50% better off than today.

However, this doesn’t make the world as a whole better off, nor does it stimulate the global economy.  It’s a transfer of money from oil consumers to oil producers.  It’s good for Saudi Arabia, Russia et al, but it’s bad for the US, Europe, Japan and China.  In the parts of the world the S&P 500 represents, it helps about 10% and hurts the other 90%.  So a rising oil price caused by cartel manipulation is a big net minus for the S&P.

Despite this, stocks soared yesterday, in robotic fashion according to the rule that stocks move in the same direction as oil.  Go figure.

– What stocks to invest in

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