The price of oil can be extremely volatile.
In this decade alone, we have seen oil trade at a low of minus $37 a barrel during the pandemic, rising to over $130 after the start of the Russia-Ukraine war.
But prices have been surprisingly stable over the past few decades. Oil prices reached $60 per barrel for the first time in the summer of 2005. It was at the same level as a few weeks ago.
That’s two lost decades.
Then we went to war with Iran and oil prices skyrocketed to over $90 per barrel. Oil has gained nearly 60 percent in value this year alone, and most of that increase has occurred since the beginning of the war in the Middle East.
Such rapid increases in energy costs will of course affect companies, households, inflation and the economy.
The war 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 its highs.
Shouldn’t rising oil prices have a bigger impact on the stock market than this?
Maybe they’ll do this if the war drags on and oil prices stay high for longer. I have no idea how long this will take.1
If you look at the historical relationship between oil prices and stock prices, the reaction to this rise in energy prices is not that surprising.
I looked at the data to see how stock market returns relate to oil price movements over the last 40 years.
What happens to stocks when oil prices rise? What happens when they fall?
You may not believe it, but the average return is actually higher When oil prices rise in a given year relative to when they fall:
Here’s a look at the data by year:
Stocks rise more often when oil prices rise rather than fall.
Isn’t this counterintuitive?
Maybe.
On the one hand, high prices can signal high inflation.
On the other hand, higher prices may indicate higher economic growth.
It depends.
Of course, the current situation has nothing to do with economic growth. This is a geopolitical situation.
So probably the most important thing is how long this war will last.
Graphic Kid Matt We looked at what happened after oil rose 5% or more for two days in a row (which happened last week):
Most of the time stocks are higher after 1, 3, 6 and 12 months.
If the increase in oil prices is temporary, the stock market impact will likely be minimal.
If the battle drags on longer than expected, you could face a much lower entry point into stocks.
Let’s see.
Further Reading:
Geopolitics and Markets
1Actually, I think the markets may determine how long this will last. People hate high prices, and rising gas prices are not a good look politically. At least that’s my theory.
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