Climateer Investing: "Lower oil price could stoke US stock bubble"

Saturday, November 29, 2014

"Lower oil price could stoke US stock bubble"

UPDATE: "Oil: So Where Does the Decline Stop?"
Previously: "UPDATED--Oil: Rout (XLE; ERY)"

The action in the oil markets is the most important story in global macro.
Period.
Right now it is the engine driving the whole narrative from currencies to GDP to junk bonds and figuring out the effects will be very profitable.
Here's John Authers writing for the FT:
Opec’s position on output could have profound consequences

Oil anchors world financial markets, and Opec has just decided to raise its anchor. The consequences could be profound, and go far beyond the power game between the traditional oil producers in the Middle East and the new generation of shale producers in North America.

Oil, it is true, is less important than it was. Steady improvement in technology has rendered the developed economies less “oil-intense”, and less vulnerable to a repeat of the 1970s, when oil price spikes twice led to savage recessions.

But ever since the postwar version of the gold standard ended in 1971, with President Richard Nixon’s decision to end the dollar’s fixed price in gold, oil has been its closest replacement as a store of value in the world economy. In the 1970s, the savage oil price spikes in terms of dollars, engineered by a far more active Opec, merely restored oil’s value in terms of gold. US economic pump-priming had weakened the dollar.

A loose “oil standard”, with Opec adjusting supply to limit oil’s volatility, has cohered ever since.

Oil anchors capital markets most clearly through its tight inverse relationship with the dollar. When oil rises, so the dollar tends to depreciate against other currencies. Typically oil exporters receive payment in dollars and then sell them, meaning that higher oil prices lead to a lower dollar.

The dollar depreciated significantly in the years leading up to the 2008 financial crisis, and its nadir overlapped closely with a speculative bubble in oil. Now, it is strengthening significantly.

That correlation with the dollar leads to a second clear correlation, with emerging market equities. They tend to outperform when the dollar is weakening (as in the years leading up to 2008), and to underperform when the dollar grows stronger.

The last period to see falling oil prices (albeit at a much lower level), and a strengthening dollar was the late 1990s. That saw a US equity bull market melt up into a full-blown bubble, while emerging markets suffered a succession of crises. A stronger dollar made it harder to pay off their dollar-denominated debt....MORE