Crude oil prices hit $80 per barrel, raise alarm bells on Dalal Street

A steady rise in crude oil prices, which hit $80 a barrel on Thursday, has raised alarm bells on Dalal Street and among equity investors. In the past, the stock markets and equity valuations have always peaked before oil prices peaked. For example, in the previous bull-run, Sensex valuation peaked at price-to-earnings (P/E) multiple of 28x in the December 2007 quarter, nearly six months prior to crude oil prices hitting a record high of $140 a barrel in June 2008. Similarly, in the post-Lehman crisis rally, the Sensex P/E multiple topped nearly six months prior to the high in crude oil prices.   

This has raised the spectre of a decline in the broader market P/E multiple and market correction, as investors become cautious about the negative impact of higher crude oil prices on India’s macroeconomic situation and corporate earnings.

Analysts say there is a peculiar correlation between crude oil prices and equity valuations. “With a certain threshold level, there is positive correlation between crude oil price and equity valuation. A moderate rise in crude oil prices indicates economic improvement and faster corporate earnings. At higher levels however, crude oil prices hit aggregate demand and corporate profitability, leading to a fall in equity valuation,” said G Chokkalingam, founder and managing director, Equinomics Research & Advisory Services. 

Experts say at $80 a barrel, crude oil prices may have entered a zone, where it may start hitting consumer wallets through higher fuel prices and corporate earnings through higher energy and raw material costs.

“Margins pressure is likely to re-emerge in the next 2-3 years, hitting corporate profitability even if they manage faster top line growth. This will make it tough for companies to meet Street earnings expectations for FY19 and FY20,” said Dhananjay Sinha, head-research, Emkay Global Financial Services.  

Analysts say the negative fallout from crude oil prices has been worsened by depreciation in the rupee against major currencies and a rise in bond yields. "A cocktail of rising crude prices, higher interest rates and falling rupee could potentially have a bigger impact on corporate profitability than what we saw in previous episodes of rally in energy prices," Sinha said.

Others, however say that it will take a while before crude oil prices start biting Dalal Street in a meaningful way. "At current level of energy prices, the markets may take a pause but is not likely to fall much either. Consumer demand and corporate earnings will take a knock only if crude crosses $90, while $100 will be a danger mark," says Chokkalingam.