Cheap crude is exposing a rift between financial markets and reality. Equities have been moving in lockstep with crude prices recently - mainly downwards. That's surprising, since cut-price oil should ultimately boost consumer demand in energy-hungry economies like the United States and China. Yet the S&P 500 Index has shed around seven per cent in 2016, mirroring the 17 per cent decline in the price of a barrel of US benchmark crude.
One possible explanation is that investors are worrying a downturn in the energy sector will hit demand elsewhere. Petroleum extraction and related services employed roughly 650,000 people in the United States in 2014, according to the Bureau of Labor Statistics, and that number is falling as weaker producers retrench. The industry is also a big consumer of steel pipes, cement and heavy equipment.
Still, it only accounted for about 6.5 per cent of the market value of the S&P 500 Index as of December 31, according to Thomson Reuters data -less than a fifth of the value claimed by industrial and consumer companies, most of which should benefit from cheaper energy. Despite the pain in the oil patch, overall US unemployment has continued to fall in recent quarters.
Another fear is that tumbling crude will eventually drag down the prices of other goods, creating the risk of a deflationary spiral as consumers put off purchasing items they expect will cost less in future. That is also unconvincing, for two reasons, according to UBS. First, people buy refined products, not crude oil - and prices of the former have fallen far less than the cost of the raw material. Second, consumers are smart enough to tell the difference between the falling price of a single commodity and broad-based deflation. Booming US car sales and signs of growing demand for durable goods suggest lower energy prices are beginning to spur consumption.
There is another scenario jittery traders would do well to consider. Stocks have been pumped up by years of near-zero interest rates. Meanwhile, although oil at $30 per barrel looks unsustainable, recent slumps in steel and aluminum markets have shown that oversupply can persist long after producers start to lose money. What some investors are taking as a signal of trouble ahead may just be market noise.
