Thursday, June 19, 2014

Oil & the Markets (excerpt)

The price of a barrel of Brent crude rose to $114 yesterday from a recent low of $104 on April 2. Rising oil prices can be a sign of global economic strength. Or else they can be caused by geopolitical crises that threaten to disrupt, or actually do disrupt, the supply of oil. In the latter scenario, rising oil prices can also cause a recession. Which way are the markets leaning right now? Consider the following:

(1) Industrial commodities. The current increase in the price of oil is obviously related to the turmoil in Iraq, and concerns that ISIS will disrupt the country’s oil production. As a result, the CRB raw industrials commodity spot price index has been falling recently. The price of gold hasn’t budged much, suggesting that the risks of higher inflation attributable to the recent rise in oil prices are offset by the risks of a recession.

(2) Stock prices. The S&P 500 was highly correlated with crude oil prices from 2008-2012. Since then, the two have decoupled, with stocks rising to new record highs since March 28, 2013, while the oil price has been moving sideways in a volatile range. The recent rise in oil prices hasn’t disturbed the S&P 500, which was back at a record high yesterday.

The S&P 500 Transportation index has also held up very well. It is down only 0.6% from its record high on June 9. Needless to say, the S&P 500 Energy sector has been boosted by the turmoil in Iraq. It is up 4.2% so far this month, and 10.9% ytd, the second best-performing sector of the S&P 500.

(3) The dollar. The trade-weighted dollar tends to be weak when oil prices are rising. Oil exporters may be diversifying some of their revenues into other currencies. In addition, if rising oil prices signal strong global economic growth, then investors may be seeking more opportunities outside of the US. Despite the recent increase in oil prices, the dollar has actually firmed a bit. This may indicate a mini flight to safety, especially since global economic growth remains subpar and vulnerable to an oil shock.

(4) Emerging markets. Rising oil prices should be bad news for emerging economies. However, the Emerging Markets MSCI has tended to be positively correlated with the price of Brent crude oil more often than not. That’s because when emerging economies are strong (weak), they tend to drive the price of oil up (down). The recent rise in oil prices hasn’t slowed the recent advance in the EM MSCI.

Today's Morning Briefing: The Plots Thicken. (1) Investors love Obama. (2) President’s critics say he is MIA. (3) Crises bring out the golfer in our President. (4) Disastrous consequences? (5) So why are stock prices up so much? (6) Are investors isolationists? (7) Why get in the middle of the Middle East’s Hatfields and McCoys? (8) So far, markets aren’t indicating that Iraqi turmoil will cause a recession. (9) Is the dot plot more information than we need from the Fed? (10) Focus on S&P 500 Energy sector, recently upgraded to market weight. (More for subscribers.)

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