“Oil and Stocks Don’t Mix” Lessons Learned From the Past
This post was originally written on March 18, 2022, 6:59 PM EST.
Markets ended the week on a friendlier note, up 6.2% for the week, back to the 200-day moving average for the broader market (S&P500) while the Nasdaq has a long way to go to repair some of the technical damage it suffered since the selloff which began in January. The United Nations High Commission for Refugees (UNHCR) is now processing more than 3 million refugees from the Ukraine, with no clear end to the conflict in sight.
Before the Russian invasion of the Ukraine, the main obstacle for stocks was the impending rise in interest rates by the Federal Reserve. We finally heard from Jerome Powell’s Fed this week and got the first interest rate increase of 0.25%, with a commitment to raise rates at each meeting to follow. On the surface, this may sound hawkish but in the context of 8% inflation, extremely tight labor markets, and continued quantitative easing (QE), it seems the Fed is not following its duel mandate of both price stability and maximum employment. In the absence of the Ukraine war, we may have been much further along in terms of normalizing interest rates, but it is clear the Fed’s policymakers have a tough road ahead. Perhaps this is one of the reasons why Tech stocks, which usually bear the brunt of multiple compression when rates rise, found a bid this week. More certainty on interest rates, beyond the uncertainties and inflationary pressures from the Ukraine conflict, would be bullish for stocks.
We also saw a top in crude oil prices on March 8th at $128 per barrel, the exact near-term bottom for the broader market, which reminds us of a report which our Chairman, Jim Moltz, wrote back in August 1990 at the onset of the Gulf War with the title “Oil and Stocks Don’t Mix”, see below. In it, he pointed out that major moves in oil of 50% or more, typically trigger opposite reactions in stocks. These outsized moves in the commodity also create highly oversold conditions, which we saw last week. The chart below highlights these severe oil shocks especially during the last major inflationary period, the 1970s. The first such oil shock came in 1973 with the surprise attack by Arab forces on Israel on Yom Kippur and the ensuing trade embargos. That was followed by the revolutionary turmoil in 1979 in Iran, a major petroleum exporting country, causing the global supply of crude oil to decline significantly, triggering shortages, and a surge in panic buying, the price per barrel of this widely used resource almost doubled.
From August to October 1990 oil prices also doubled as a result of the Iraq war. Stocks went down about 15% during those 2 months before bottoming on October 5 1990 setting up the 2nd longest bull market in history which lasted 10 years. We will see if the more than doubling of crude oil prices over the past year is sustainable, or if we see a reaction in the form of demand destruction as a result of these highly elevated prices. A moderation of inflation would certainly be welcome if the Fed is to orchestrate a soft landing in the US Economy and avoid stagflation. One thing we have learned from history, severe oil spikes create interesting entry points for stocks in near term. Stay tuned!