Wherever oil goes, the stock market goes | Hacker News Reader

Wherever oil goes, the stock market goes

bloomberg.com

110 pointsjseliger81 comments

Can anyone explain how exactly cheap oil makes the stock market crash? Gas companies do not make up most of the stock market. Cheap energy means cheap everything else. Sense when does cheap energy cause everything else to crash?

cheap oil is not the cause of the market crash, but rather they are both caused by the same problem - fear of recession/depression. Cheap oil (along with many other commodities) have been falling quickly over the past 15 months. Increasing supply combined with "China contagion", ie lower demand growth, have caused inventories to rise. In this case, oil becomes a proxy for "demand", and since it keeps building, that means global economies are not growing. This is further exacerbated by quantitative easing policies that encouraged investment in the past 7 years where-ever there might have been any sort of return. This kept the economy afloat, but it could be argued that it was keeping a zombie economy afloat. These policies are now coming home to roost - over-investment led to oversupply now meets lack of demand.

Stock prices are always inversely correlated to fear.

You sure? We can measure stock prices. Can we measure fear?

The argument is the opposite direction: if companies don't expect to be selling many products in the near future, they'll cut their orders for materials. So a fall in commodity prices can be the first sign of a coming recession. (In this particular case it seems that the fall in oil prices is more about increased supply than lower demand. As Nevsky famously said recently, historically logical correlations between different asset classes can remain in place long after they have ceased to be logical)

> the fall in oil prices is more about increased supply than lower demand

Even so, it's worrying. It means that oil companies have (collectively) predicted a much higher future demand growth than realized. This suggests that the world's economies aren't growing as quickly as they used to (many fingers are pointed at China), and could spell troubles for other industries who have also invested heavily, anticipating future growth that won't come (so soon).

No it doesn't, it's political.

Are the Saudis hoping they can limit the benefit (to Iran) of the opening of Iran's markets enough to tip the scales the next time there's a decision to be made about either defying the West or keeping markets open, such that they become isolated again? All that I've read about their recent moves claims that they're doing it to counter Iran, but that doesn't seem like it'll work long-term unless they expect Iran to be out of the game again fairly soon. Otherwise they're just wasting money for a delaying tactic.

The Saudis are doing it not just to counter Iran - they also have to compete with South American, Canadian, American, and Russian oil. They've increased the volume of production to keep the prices artificially low in order to squeeze all of those players out of the market. It's also why Russia has a vested interest to act in Syria, propping up the Assad regime - to keep their oil under the control of an entity friendly to their interests.

I think the Saudis are gambling they can keep it together politically and financially longer than their competition can, leaving them with a de facto monopoly.

It's a very ballsy move, but it's also a very dangerous one, because the Saudi regime relies heavily on direct patronage - handouts - and if those stop happening there's a real danger of instability.

It's also very dangerous to poke Russia too hard, because Putin really isn't likely to say "Fine then, I'll just give up."

This could all end very badly for everyone.

Or maybe, as many people have argued, Saudi Arabia realized that OPEP (and the non-OPEP players) are simply not disciplined enough to bring their production down enough to move prices up.

So they've decided to fight for market-share this time. And they can, since their production prices are on the low side.

Also one of their few friends in the middle-east who also happens to be a big customer for Russian military hardware. But yeah, the Saudi's are engaging in pretty classic cartel behaviour, in response to Iran and US shale: https://en.wikipedia.org/wiki/Predatory_pricing

It gets more bizarre though. Putting aside economics, the US, the Saudis and the Iranians all have a pretty aligned geo-political reason for pumping the oil hard: ISIS.

Politics and war make strange bedfellows.

Who's oil ? Syria's ?

Syria's production is close to Belarus's production and behind Cuba's. And even before its decline it was behind Ukraine's production.

It's not a big enough player for anything. Especially for a juggernaut like Russia.

Syria has Russia's deepwater port in the region. They won't give that up easily.

I was just thinking, if we really do stop using oil for transportation, that means at this point there's probably a fixed number of barrels that are going to get sold, period. That's going to become cash, and the rest of everyone's oil is going to stay in the ground. Well, there will always be a market, it'll just be fundamentally smaller potatoes.

But so if there's only so many barrels of oil going to be sold, then at this point it really is an all-out scrap for market share. Maybe Saudi Arabia is aiming to just to divest themselves of the majority of their reserves while volumes like that can still be moved at all, i.e., over the next 20-50 years.

If this is a 20 year game then it's time for bold moves.

> It means that oil companies have (collectively) predicted a much higher future demand growth than realized.

That might be an over-extension of the markets-as-preditive-tool view. I am more inclined to see the current prices as a consequence of latencies in the oil markets that prevent it from showing true supply and demand accurately. When prices were high, too many new wells were drilled at once because it takes a long time for the new oil to hit the market and bring prices down. When the new oil hits the market and starts reducing the price, none of the producers can cut back on what they send to market because they have to pay off the loans that they used to drill their wells in the first place.

The supply side is structurally unable to respond to demand, regardless of what they predict future demand to be.

I think this is right. Reminds me of the beer game: https://en.wikipedia.org/wiki/Beer_distribution_game

Oh look, there's a version you can play online: http://forio.com/simulation/harvard-business-school-root-bee...

I think the increased supply is partly a matter of Iraq's recovery, the lifting of sanctions on Iran, and perhaps also the rapid increase of US production since 2011 (partly due to fracking?) These producers want revenue more than they want a high price.

Libya is also sort of coming back

The reason is largely physological. The stock market traders think oil price is an indicator for demand. When demand goes (=oil price) down this indicates the end of a bull market and the begin of a bear market. So obviously they want to sell their stocks before the price goes down naturally which causes a stockmarket crash.

Which would mean that when other producers see that demand for _their_ products hasn't actually fallen (and hopefully rises because gas-buying consumers have more money in their pockets), we should see a nice bounce back in stock prices for everyone but oil?

At a simple level its supply and demand. We currently have a high supply and low demand (less travel during the winter months) which in turn drives down prices. Lower prices, means the energy sector is making less, when it makes less, people don't invest because it won't make you any money.

At a more complex level, you have a war between US oil producers and OPEC (Organization of the Petroleum Exporting Countries). OPEC wants to put the US oil producers out of business. The US producers have started to give OPEC competition, driving down oil prices. The result has been an oil boom to oil crash. Lots of companies that were hiring are not hiring and in some cases, cutting jobs. Cutting jobs impacts employment numbers, employment numbers affect investments, the fed rate and a whole host of other things.

While the energy sector won't make the market crash by iteself per se, it will certainly drag it down and make investors a lot more skittish to put more money into the market - having the effect we're currently experiencing.

There's at least 35 companies in S&P500 directly related to Oil & Gas (equipment, drilling, distribution, refining etc). While 7% is not "over-represented", but it's not insignificant either. How would S&P performance look without these 35 companies?

The Guardian actually covered that in a short article last month. http://www.theguardian.com/business/2016/jan/21/oil-prices-s...

There are also a number of companies (some in the S&P 500, more of them not), that get all or most of their revenue by providing services to the "obviously" oil & gas companies. You've got large steel and railroad companies, then you've got small contractors providing welders/machinists/millwrights/etc.

Indeed. I have personally worked with two such companies that sold equipment and services to oil and mining companies. Both those sectors have been hit hard and their suppliers (esp. ones who had not diversified well) were hit in turn.

There are a lot of interrelated factors. You can take any commodity and produce infinite number of similar articles "Where commodity X goes market goes".

Oil is the rate limiting reagent for industry, so causation goes the other way. A rapid oil crash is a clear indicator of a slowdown.

That is only one side of the equation.

Due to rapid technological advances in shale oil extraction (ie fracking), North American companies have radically changed the daily global supply of oil, which of course puts downward price pressure on it.

Much of the recent price drop can be defined in terms of Saudi's getting into a price war with these NA companies, trying to push them off the market.

Not only that, but this technology is a long-term game changer, ie it will be only a matter of time before all the world oil players (Russia, Venezuela, etc) co-opt this tech and start extracting much cheaper oil from their fields, which of course the markets are anticipating as well.

Hmm... and combine with EVs coming of age, a Moore's Law type growth curve for solar (and solar EROEI), etc., and perhaps the high energy costs of the recent past are gone for a while.

I have to admit I'm surprised. I totally bought the idea that oil would never be this cheap again for fundamental physical reasons. But perhaps that made it a bubble. A true bubble must have a "story" about how it's "different this time" that manages to convince huge numbers of people.

You wouldn't be the first person to be on the losing side of a bet against the technical and capitalistic abilities of American business.

Luckily, I made no (financial) bet. :)

Why do people keep saying this? I thought it was agreed on that production had already gone up a lot months ago due to fracking and now due to Iran. Many posters also seem to completely ignore the supply side of the equation. Why?

I think I'm in disbelief that there can possibly be so much of this stuff.

I recall years ago though reading a debate between a peak oil "doomer" and someone saying climate change was the bigger problem. The latter kept saying we have more oil at higher prices and that the real problem is we have "enough carbon to destroy the world." If we really got desperate and decided we didn't want Florida we could do deep in situ conversion of massive conventionally unreachable reserves of very deep coal into gas ("water gas reaction"), then liquids. That could, he said, keep our liquid based transport economy going for thousands of years but would send Earth back to the Permian.

Your climate change friend was right. The technology for converting coal into oil has existed for decades. Nazi Germany used it during WWII. Peak oil is a scientifically illiterate concept. Of course, these days, it would be smarter to use micro-orgranisms to create oil from some energy source and feedstock (like solar).

Cheap gas means cheap transport, means cheap energy, means cheap manufacturing. It is good for the economy. The thing is, it takes adjustment and stability for these benefits to work out. And also, too much of our economy is tied over speculation on oil related goods.

If the oil prices stay low (which is totally unsure) then it will be beneficial over the course of a few year, but right now the economy is adjusting.

In general, even, "And also, too much of our economy is tied over speculation."

When reading about the markets and in general, finance stuff (which I do and enjoy actually), there are times that I feel as if we have just entangled ourselves in the most epic, largest and most complex system of epicycles on epicycles that we have ever seen.

I know this is very simplistic, and in the end there is probably some reason below all of this... but sometimes, it just doesn't look like it.

Alan S Blinder recently pointed out that cheap oil is mostly good for the economy (except in North Dakota and Iran). He also pointed out that markets can stay irrational for a long time.

I don't think oil is the cause of the market drop: stocks had been overbought for a while (if you look at historic P/E ratios), so it is natural for it to return to normal.

Also, the increasing interest rate is going to put downward pressure on the stock market, even if the economy does well. Right now that is what I consider to be the main cause of the drop. What I mean is:

In the market, there are day-traders, and long-term traders. The day traders are mostly responsible for the day-to-day gyrations of the market, and they've been looking at the price of oil as something to follow. Underneath that, though, the long-term traders have been removing money from the market (leaving it in cash, or switching to bonds), so even after the day traders get done, there is still a net negative.

Of course, that's a simplification for explanation purposes because I don't want to write a book here.

> ... (except North Dakota and Iran) ...

And Norway, and Russia, and probably others.

The economy in Norway looks pretty bad right now. And Russia is having very bad times right now I believe.

At least in Norway it's because the oil price is way to low for them -- I heard that they break-even at $60 or $70 per barrel. That's pretty bad if practically the whole economy is based on oil.

Not whole economy is based on oil. It makes 30% of revenue and 50% of exports.

https://www.regjeringen.no/no/aktuelt/the-norwegian-experien...

50% of exports is pretty bad in a world where you need/want things like iPhones and don't make them yourself. We're all very connected at this point.

Norway is near the high end with cost of production at $36.10 / barrel.

http://money.cnn.com/interactive/economy/the-cost-to-produce...

> Also, the increasing interest rate is going to put downward pressure on the stock market, even if the economy does well. Right now that is what I consider to be the main cause of the drop.

Really? The 10-year Treasury yield (the best measure of long-term rates) has declined by 25% since the start of the year. No one is forecasting Fed interest rate hikes in 2016 anymore.

Long term yields lower in response to tight money, not loose money. Economists who study market expectations found that the 10 year treasury actually rose with QE expectations, for example. This is rational: lower inflation and stagnant economy -> lower interest rates.

At one point in time (sorry, I forget when) there was a surprising (to some) announcement of QE during which you could observe the result directly. The Fed announced it would buy more long term bonds, and the price of those long term bonds fell.

It is also possible to disturb the equilibrium in one direction while moving it in the other direction. In the example above, the change in equilibrium (higher interest rates) outweighed the disturbance (lower interest rates).

> I don't think oil is the cause of the market drop: stocks had been overbought for a while (if you look at historic P/E ratios), so it is natural for it to return to normal.

If stocks are overbought, is that an indicator that there's a huge amount of money out there chasing returns? Returns it can't find elsewhere?

Returns it has to find, otherwise you lose out due to inflation. I fully agree with you that there is a huge amount of money "chasing returns". Though I'd argue that it's more of a case of it being forced into chasing returns by virtue of all sorts of market distortions.

A simple example is that of capital gains. Which is "taxed" at a lower percentage (at least in USA) than normal salary/profit income. I would argue that this simple and relatively benign-looking "incentive" is actually a market distortion that has far-reaching consequences.

> Returns it has to find, otherwise you lose out due to inflation.

That's my concern really. Money is running out of places to go.

* stocks (overbought)

* real estate (still recovering from the last failure; already overbought in major markets)

* auto loans (I hear murmurs we're in a subprime auto lending bubble)

* oil (obvious!)

If you're chasing returns, and you can't beat inflation (because you can't find those returns), your cash is slowly becoming worthless. Note my concern isn't because I have cash to invest: its because of the damage that rush of money has as it races into new "investment opportunities".

So if you can't find a better return, you just drop everything into physical possession of precious metals, as the "inflation" there is limited to the amount of additional metal that mining can extract from the Earth. Paper money inflation is limited only by the number of bytes you can fit in your central banks' computers.

You still lose purchasing power in a relative sense over time, but limited to about a -1.5% per year for inflation-adjusted gold.

But really, it isn't that difficult to find an inflation-adjusted return better than -1.5%. Even a local family-owned restaurant could probably manage to eke out +0.1% or better just by hiring a part-time professional food-service manager to overhaul the formerly ad-hoc business strategy of mom and pop.

The problem is that many large investors don't even want to bother with thousands of small businesses, because you need to invest in a lot to average out their risk factors, and each of them would require a lot of individual attention to become more profitable. Large-scale investors don't even want to deal with just a single chain restaurant brand like Olive Garden or KFC, so they buy Darden or Yum! instead, because food service is such a low-margin sector overall that you literally need thousands of restaurants in your portfolio in order to be a worthwhile investment to someone that is hands-off.

Small business discovers it is more difficult to find investors with both the money to burn and the time to spend babysitting a relatively small investment. VCs don't want to invest $100k in a small business, restructure it, and then get $200k of value back; they want to invest $10M in a small business, restructure it, and get $100M back. Even if you could somehow bundle up all the locally owned single-location restaurants in the US, divide them up into grades and classes, and resell to investors, it would still be an unpopular place to park money. But if you could instead convince all those restaurants to take out small business loans, and you resell those, you're suddenly rolling in money. Lending is just a better, safer business to invest in than small-time food service.

This can only become a systemtic concern if the growth of money and velocity exceeds GDP growth. In such a case, you would expect inflation (or huge asset bubbles) and relatively there is little in the US.

Real estate prices are well in historical norms compared to rents (http://www.economist.com/blogs/graphicdetail/2015/11/daily-c...)

By what measure are stocks overbought? If we blindly look at earnings, stocks have an earnings yield of about 3% over a 10 year Treasury note, well within accepted ranges (http://www.investopedia.com/terms/e/equityriskpremium.asp)

Could you give more detail about how capital gains taxed at a lower percentage than salary/profit has far-reaching consequences?

Well, it simply makes people favour capital gain/growth over other sources of income.

So, for example, CEO's would prefer their compensation in stocks rather than getting a salary.

It contributes to skew in terms of buying property or capital that'll "appreciate" or get speculated on. Rather than investing in creating a business that'll pay dividends.

Most investment these days is speculation, or the expectation of "increase" in the capital value of the investment. Dividends are practically non-existent, and are a tiny fraction of the "return" you get simple from increased capital value. This, I would argue, gives companies/organizations/corporations the wrong signal. It tells them to optimize for "capital growth" of the stock, because that's what investors want/expect. So that means pumping profits back into the company itself (which requires reducing dividends to token amounts) and aiming for "growth".

To be honest, it'd be difficult to quantify exactly how much the different tax-rates skew the markets. And you have to take it along with the rest of the market distortions. E.g. Retirement annuity tax benefits, or property-ownership tax benefits.

>I don't think oil is the cause of the market drop: stocks had been overbought for a while (if you look at historic P/E ratios), so it is natural for it to return to normal.

p/e ratios are historically very low relative to interest rates

Because interest rates are very low relative to historic values. But they may not stay there; the Fed is starting to raise them. If they continue to do so, you're not left with the abnormally low interest rates, and so all you have is that stocks are high relative to P/E ratios. (I know, if...)

consider this simple proof:

price is a function of supply and demand.

oil prices are low because demand for oil is low

oil is an input into nearly every aspect of the economy

thus low demand for oil could imply low demand for goods for which oil is an input (it could also reveal some kind of major efficiency improvement or the presence of some substitute for oil (or an increase in the supply of oil).

Or oil prices are low because the supply of oil has increased.

Yeah, I thought it was pretty established that even before sanctions against Iran had been lifted production already had gone up especially in the US through fracking.

False assumption in a proof?

that could also be the case. Or the increase could be a combination of changes in supply and changes in demand.

Cheap oil means countries such as Saudi Arabia must sell stocks in order to finance their expenses. Together, state owned oil funds own a single-digit percentage of all publicly listed stocks.

People have demonstrated that oil prices (especially in the short term) do not simply reflect supply and demand. It's a naive view. Especially as more "pure" speculators enter the market.

They call this more "fast money" in the mkt. More highly leveraged participants, etc.. Those speculators impact price and generally speaking selling begets more selling and vice-versa - and you get a more volatile market.

It has only been established a recent correlation between equities and oil. There could very well be factors driving both markets in the same direction, or it could be (and most people don't like to accept the concept) a good old-fashioned coincidence.

There was a nice article on seeking alpha which speculated that sovereign funds of countries like Norway and middle eastern countries used the opportunity of high equity prices and low oil prices to sell. This large selling pressure has give some drop in prices. That makes sense to me. There has to be selling pressure to lower prices and I think that is a good cause.

Public banks have massive loans to oil producers. When oil goes down, much of this production becomes unprofitable, leaking to bankruptcies and defaulting on those loans. So oil affects the banking sector, too.

Cheap money. Plenty of people have had years to buy assets with cheaply borrowed money. The Fed increased interest rates, people started to unwind their positions in oil and the stock market, that sets off a self reinforcing cycle that pushes prices lower forcing more people to sell in order to break even or limit losses.

There used to be something called the petrodollar:

https://en.wikipedia.org/wiki/Petrodollar_recycling

The idea that the major oil producers earned such a windfall that their money immediately would be sent back to the west in form of investment.

Today I think it is more complex and the low oil price is both a cause and a symptom of something that is mostly not so good.

For a while, hedge funds such as Bridgewater have built a correlation between oil and stocks in their models. Bridgewater's all-weather fund did badly in the last two years. The CNBC anchors were bought into this and they were quite surprised that the oil price plunged and the stock market stayed high as long as it did.

"Sense when ..."

I believe you wanted "Since when..."

This article is entirely wrong.

Wherever the dollar goes, stocks and oil go (in the opposite direction). They're both priced in dollars fundamentally.

The Fed ending QE mostly put a stop to the stock market moving higher, dramatically strengthened the dollar, and decimated the commodities market, devaluing the price of nearly all commodities including oil.

If the dollar goes up a lot, it becomes extremely difficult for the stock market to do anything but fall. Earnings growth has to outrun the gain in the dollar. During especially fast climbs in the dollar that becomes essentially impossible. To make things even worse, the S&P 500 companies are highly dependent on exports, they get to show off artificially high earnings courtesy of a too-cheap dollar; when that condition turns, the artificially high earnings go with it, which is exactly what we're witnessing now. Then doubling down on that effect, the stronger dollar is pulling trillions in capital back out of emerging markets, which has thrown most of them into recessions or worse, leaving the export heavy companies in an even worse bind.

Cheap gas + cheap stocks. Sounds like this is a good thing unless you're either a) a full-time investor, or b) retired or planning to retire very soon.

If you're working a job and putting money into an index fund for retirement, then news like this should make you smile and maybe put a little extra into your IRA/401k/etc. next paycheck.

Ideally, if you're getting ready to retire, most of you assets should not be in the volatile stock market, so it should not affect you terribly.

If you intend to live for 30 years in retirement, shouldn't you still have a good chunk of your assets in stocks?

Many people use much of their retirement savings at the moment of retirement to buy a special retirement-income product. This can have tax benefits over normal investments. So you try to maximize the probability of having a large fund at that moment.

Cheap stocks? To me, everything looks pretty inflated from the QE fun we've had since 2009. What goes up, must come down. And over the past 7 years, stocks have gone pretty far up. Now the party is over thanks to the Fed.

Or, to put it more visually, take a look at the graph of the S&P 500 since 1994: http://i.imgur.com/5Kn5XJM.gif

I think that does a good job of illustrating our problem here.

Have you tried adjusting it for inflation and GDP growth?

Even after that, the S&P 500 should be doing better. Why? Because the S&P500 represents the winners not the overall economy.

A regrettable consequence of cheap oil is that clean energy technologies become harder to deploy because they're competing against a lower cost alternative. The best thing EVs and solar had going for them was $100+ dollar per barrel oil in prior years.

I'm a complete layman in this field - but looking at the oil price charts it seems that its never been lower. Even from production/export cost from various countries - it doesn't seem like this price can go on for prolonged periods. I.e. it seems to me that it has to go up...

Any experts here - would this be a sound assessment?

Also (again as a layman) - what would be a good way to bet on this? I.e. can I buy crude oil options virtually, hold them for 1-3 years and sell them as easily as I could stock online? What would be the best way to do this + any lowdowns (except that my bet might be wrong)?

Many people believe that the prices will stay the same for at least the next 2 to 3 years. Some of those people think they will go down to about $20 for a while.

Oil and stock market correlate? Nope ...

"It is popular to correlate changes in major factor prices, such as oil, and the performance of major stock market indexes ... Andrea Pescatori, an economist at the International Monetary Fund (IMF), attempted to test this theory ... his variables only occasionally moved in the same direction at the same time, but even then, the relationship was weak. His sample revealed that no correlation exists with a confidence level of 95%."

http://www.investopedia.com/ask/answers/030415/how-does-pric...

This is simply a badly written article. In 2008 oil was very high, the market was not. Now in 2016, oil is very low, and the market is heading down. There's little correlation, and the market conditions today could be argued to be a result of bad regulation and poor government interference in the private sector (conservative view anyway), and now people want even more government influence when it's in $19 trillion in debt and the Federal Reserve mark to market is insolvent.

> In 2008 oil was very high, the market was not.

In 2008 oil and the market was very high and they both crashed toward the end of they year and into 2009.

https://en.wikipedia.org/wiki/World_oil_market_chronology_fr...

There is pressure on both sides of the equation. The supply is high because of shale oil and Iran. On the other hand the growth projections for economies, demand side, has not materialized. So yes. Oil price is low AND the economy is tanking. The simple narrative of wherever oil goes etc does not really work any ways, mostly because oil industry and associated industries is a big part of the economy.

Not to mention the fact that its production is, at various times:

a) The result of cartel manipulation (OPEC)

b) A tool of economic warfare (ISIS), and punishment (Russia)

Unfortunately both of those are happing at the same time as well.

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