The price of oil can be extremely volatile.
This decade alone we’ve seen a barrel of oil trade at a low of negative $37 in the pandemic and more than $130 following the start of the Russia-Ukraine war.
But prices have been surprisingly stable over the past couple of decades. Oil prices first touched $60/barrel in the summer of 2005. It was at the same level as recently as a couple of weeks ago.
That’s two lost decades.
Then we went to war with Iran and oil prices skyrocketed to more than $90/barrel. Oil is up close to 60% this year alone with most of that increase coming since the start of the war in the Middle East.
Energy costs rising that fast will certainly have an impact on companies, households, inflation and the economy.
The war has caused some volatility in the markets but probably not as much as you would expect. The S&P 500 is down just 3.4% from the highs.
Shouldn’t rising oil prices have a bigger impact on the stock market than this?
Maybe they will if the war drags on and oil prices stay higher for longer. I have no idea how long this will last.1
If you look at the historical relationship between oil prices and stock prices, the reaction to this energy price spike isn’t quite so surprising.
I looked at the data to see how stock market returns correlated to oil price movements over the past 40 years.
What happens to stocks when oil prices rise? What happens when they fall?
You might not believe this but average returns are actually higher when oil prices rise than when they fall in a given year:
Here’s a look at the data by year:
Stocks have been higher more often when oil prices are rising rather than falling.
That’s counterintuitive right?
Maybe.
On the one hand higher prices could signal higher inflation.
On the other hand higher prices could signal higher economic growth.
It depends.
Of course, the current situation has nothing to do with economic growth. It’s a geopolitical situation.
Therefore, the thing that likely matters most is how long this war lasts.
Chart Kid Matt looked at what happens after oil jumps 5% or more two days in a row (which happened last week):
Most of the time stocks are higher 1, 3, 6 and 12 months later.
If the oil price hike is transitory the stock market impact will likely be minimal.
If the war lasts longer than anticipated…it’s possible you will get a much lower entry point in stocks.
We shall see.
Further Reading:
Geopolitics vs. Markets
1I actually think markets could dictate how long this lasts. People hate higher prices and rising gas prices are not a great look politically. That’s my theory at least.
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