Are low oil prices good or bad?
On one hand, you might think low oil prices are good as the resulting low energy costs are good for the businesses and consumers that buy it. Ideally, they will take those newfound savings and throw it right back into the economy.
On the other hand, very low oil prices make can cause all sorts of problems for producers, which include the drillers who bleed money and in extreme cases shut down, tightening supply. There are the banks who could struggle as they see their borrowers in the energy sector go delinquent and default. There are also the oil-driven economies, like those in the Middle East, which may face everything ranging from social unrest within to war with its external competitors.
Currently, the market seems to be reacting more negatively than positively to low prices. Take today: the S&P 500 is down 3%, but WTI crude oil is down 6%.
“This recent fixation on oil is only starting to show up in the rolling correlation numbers,” Brean Capital’s Peter Tchir said referring to the US stock market. “We have seen higher correlations in that past. At the same time, as recently as this summer the correlation was NEGATIVE!”
More tangibly, there’s the risk to earnings. In recent weeks, strategists across Wall Street — including RBC Capital, Deutsche Bank, Goldman Sachs, and Citi — have all warned clients that the outlook for earnings was rapidly deteriorating. And earnings and the expectation for earnings growth are the most important drivers of stock prices.
In a note to clients Wednesday, Gluskin Sheff’s David Rosenberg shared this cool chart showing oil’s increased correlation to stocks and bonds.
“[A]s we have pointed out this selloff is correlated significantly with the oil price which has sliced to around $27 per barrel this morning,” Rosenberg said. “This means rising default risks, spillover effects to related sectors as the near-term negative effect from sharply lower oil swamp the benefits which accrue over the longer-term.”
“And at this stage, it is more about the speed of the decline than actual levels which has unnerved investors — it is one thing to go from $100 per barrel on WTI to $60 where most energy companies are still profitable versus $100 per barrel to $30: a level where defaults, bankruptcies, job and production losses accelerate.”
For now, everyone’s just selling everything.