Monday, December 28, 2015

Stock Market: Worshipping The Wrong God

(Drivebycuriosity) - "The stock market is worshipping the wrong god", says Jim Cramer (alpha). The CNBC host hit the nail on the head. The US stock market is fixed on the price oil. Today Dow Jones & S&P 500 again closed in the red "pressured by another downdraft in oil prices", writes Reuters (reuters marketwatch). In the recent weeks dropping oil prices (today minus 3%) regularly were accompanied by falling stocks.

The bonding between stocks and oil doesn´t make sense. If the stock market would respond rational, then falling oil prices would cause rising stocks. History shows that cheaper oil is positive for the global economy.

In the year 1986 happened a similar oil price collapse. Then Saudi Arabia flooded the markets - as they do today - to get rid of their competitors  (wsj this link has a paywall.You can bypass by copying the link into google). "In late 1985, Saudi Arabia abandoned its swing-producer role, increased production, and aggressively moved to increase market share" (freerepublic). The sudden oil flood caused the oil price to collapse from $30 to $10 (minus 70%  morganstanley). After the 1986`s oil crash followed a period of relatively cheap oil and other commodities till around 2003 (chart below).

 The oil price collapse didn´t cause a recession. The US economy grew in the years 1986 & 1987 each 3.5% (annual GDP growth) and accelerated to 4.2% in 1988 (worldbank). In the period 1985 through 2000 cheap commodities in combination with falling interest rates and a technological revolution (Internet) induced a period of prosperity (with the exception of 1992 as the first Iraq war caused an oil price spike which caused a mild and short-lived recession), the longest boom in U.S. history (factcheck).

The recent oil price collapse - and the oil crash from 1986 - work like a global tax cut. Consumers world wide have more money to spend for other goods & services. Companies  have less cost for energy & materials. And dropping energy prices translate into lower transport costs which makes almost anything cheaper. Food prices drop as well because transport costs are lower and farmers spend less for diesel (tractors, harvesters). Lower prices for other commodities like iron, steel, aluminium and like reduce the cost to produce cars, bridges, airplanes, harvester significantly.

I suppose that the global economy will respond posetively to cheap commodity prices and the stock market rally will restart.

PS I am aware that in the years 2009-2014 stocks & oil prices climbed together. But this was an exception. Zero interest rates and QE programs fueled the appetite for risky assets in general. I expect that the markets will be more selective in the future and commodities will stay cheap because the technological progress will encourage supply (fracking) and curb demand.

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