Why Are Stock Markets Worried about Low Oil Prices? - The 5 Minute WrapUp by Equitymaster
Free Reports

Why Are Stock Markets Worried about Low Oil Prices?

Feb 3, 2016
In this issue:
» How markets react to changes in Monetary Policy?
» Mammoth outlay under the Food Security Act
» ...and more!
0:00
Radhika Pandit, Managing Editor of ValuePro

My aunt asked me a smart question the other day: Why are stocks falling because of plunging oil prices? Aren't low oil prices actually a good thing?

Probably. But as always with oil, things are a bit more complicated than they seem.

For the last 75 years, the culprit behind 'oil shocks' has usually been high - not low - oil prices. The series of oil shocks in the 1970s is a classic case in point. In 1973, Arab oil producers imposed an embargo, which caused crude prices to spike from US$3 to US$12 per barrel in 1974.

That high oil prices cause shocks to the economy is understandable. Pressure on government finances mounts (especially for oil importing countries). The high prices eat into disposable income. Consumption takes a big hit.

So when the reverse happens, as it is now, why do markets react negatively? An article in Newsmax tries to explain this.

In the last several years, more so since the 2008 global crisis, the emerging countries have come into the spotlight because of their high-growth potential compared to the developed world. As growth in the rich Western countries has slowed, many global companies have relied on emerging markets to shore up overall performance. Barring India and China, many of these countries are oil and commodity exporters.

So the rout in oil as well as other commodities has wreaked havoc on the emerging countries, thereby denting the earnings growth of major corporations. Indeed, the world's economy relies far more today on emerging countries than it did 15 or 25 years ago. These economies now account for nearly 40% of global GDP, about double their share in 1990, according to the International Monetary Fund.

The plunge in oil prices, therefore, has severely restricted growth in these emerging countries. And now we have a situation where the rich world is not growing and the emerging world is slowing.

The other big change in the oil landscape is the US. The boom in shale oil production in the country has the US vying with the Middle East and Russia as the top oil producer. This was not the case a few years ago.

Now, the major argument in favour of low oil prices is the boost in global consumption. So far that has not been happening at the pace envisaged. For instance, in the US at least, so scarred is the average American by the global credit crisis, that any savings from low oil prices are being used to retire debt rather than go on a consumption spree.

India and China, the two biggest oil guzzlers, are not seeing a drastic pickup in consumption just yet. China's economy is in fact slowing and demand has waned. The Indian economy is also yet to pickup in a big way.

What does all of this mean? Only that there are too many factors that influence the movement of oil prices. And that's why we never claim to be experts on where oil prices are headed next.

Our broader view is that oil prices are not sustainable at such low levels for a long time because it doesn't encourage the kind of investment the industry needs. The long-term trend suggests that oil prices will average somewhere around US$60-65 a barrel with many spikes and plunges along the way. We believe this is the best approach for a commodity as complex and vital as oil.

Do you think that low oil prices are a good thing for the global economy? Let us know your comments or share your views in the Equitymaster Club.


--- Advertisement ---
Profit From Junior Blue Chips...

We have released our latest Special Report on the best of the best small caps - Junior Blue Chips!

Yes, we believe Junior Blue Chips possess the high growth potential of small caps along with the stability of blue chips.

That is an amazing combination every investor would want in his portfolio.

And the best part is you can get this report for FREE!

Just click here to know how...
------------------------------

3:03 Chart of the day

Stock markets tend to react to every bit of information either on the micro or the macro front. And most of the time, such swings hardly make sense. One such economic event, which influences market movements is the announcement of Monetary Policy.

Markets reaction to change in Monetary Policy

As seen in today's chart, when the RBI announced a rate cut, the Sensex gained. But when the RBI maintained status quo, the Sensex did not always react positively.

But as a serious long term investor, such market movements should not bother you. As we have discussed many times in the past, such policy decisions should not impact the way you go about investing.

Investors should bear in mind; monetary policy is nothing more than a liquidity management tool for the central bank. And should be perceived as a signal of the broader macro trends. When it comes to investing in stocks, the focus has to be on the soundness of the business model, management quality and reasonable valuations.

4:01

As reported in today's Economic Times, the Indian government is in the process of announcing a mammoth outlay of Rs 1,300 billion, under the National Food Security Act (NFSA). This is double the number allocated in current year's budget. Reportedly, Food Security Act is expected to come into force from April 1 and will cover more than 70 crore beneficiaries across 27 states and union territories.

Two issues are often discussed when such big bang announcements are made. One, will the actual beneficiaries get what is intended for them? And two, will the government be able to fund the planned allocation?

Let's take the first issue. The government has been taking various steps to ensure the policy is implemented and the beneficiaries gain from the Act. So far, programs such as these have been the hotbed for corruption. So it will be interesting to see how the government chooses to tackle this issue.

Coming to the second aspect, in our view the plunge in oil prices seems to have given some leeway to the government when it comes to its finances. This is despite the poor agricultural production caused by erratic rainfall.

But is that enough to fund the allocated expenditure without putting excess pressure on the Budget bill? That is the big question.

4:45

After opening on a weak note, Indian markets have continued to languish in the red. At the time of writing, BSE Sensex was trading lower by around 200 points. All the sectoral indices were witnessing selling pressure, with stocks from power and realty facing the maximum brunt. Stocks from both the smallcap and midcap spaces were not spared either. The BSE Midcap and BSE Smallcap were trading lower by 1.3% and 2% respectively.

Editor's Note: Noted economist Mr Savak Sohrab Tarapore, who wrote the column Common Voice for Equitymaster, passed away today. May his soul rest in peace.

4:55 Today's investment mantra

"What we learn from history is that people don't learn from history." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Radhika Pandit (Research Analyst) and Bhavita Nagrani (Research Analyst).

Today's Premium Edition.

'Are Smartwatches a Threat or Opportunity for Titan?'

A discussion about the company's recent foray into the smartwatch segment.
Read On...Get Access

Recent Articles

You've Heard of Timeless Books... Ever Heard of Timeless Stocks? August 19, 2017
Ever heard of Lindy Effect? Find out how you can use it to pick timeless stocks.
Why NOW Is the WORST Time for Index Investing August 18, 2017
Buying the index now will hardly help make money in stocks even in ten years.
This Small Cap Can Drive Chinese Players Out of India (and Make a Fortune in the Process) August 17, 2017
A small-cap Indian company with high-return potential and blue-chip-like stability is set to supplant the Chinese players in this niche segment.
This Company Beat the Business World's 'Three Killer Cs' August 16, 2017
And what it has in common with beating the stock market too.

Equitymaster requests your view! Post a comment on "Why Are Stock Markets Worried about Low Oil Prices?". Click here!

3 Responses to "Why Are Stock Markets Worried about Low Oil Prices?"

rajesh awsthi

Feb 4, 2016

emerging economies which are mainly oil producing countries slowed down becouse of low oil prices on the other hand it severely effected the already slowing down developed economies becouse of their declining exports to these countries.so overall world economy got slowed down which effected the stock markets resulting in weak sentiments of our markets too.thats why i feel our markets are worried.

Like 

Alok Kumar Jha

Feb 4, 2016

Low oil prices are good for non-producers of oil. In medium term, low oil price would perk up the growth engine in such countries, including the developed countries. However, since US (Shell) itself is a major producers of oil, US would be insulated from such growth, thereby limiting the overall prospects of revival worldwide given the stronghold of dollar over other currencies. Since oil is a limited resource, and solar is yet to pick up, I agree with the view given in the article that the oil price would settle at around $ 60 per barrel for a longer duration and then would further inch up with depleting oil reserves in future.

Like 

M Muralidharan

Feb 3, 2016

Indian consumers have not been benefitted significantly by the lower prices as our Government has swindled all the benefits.....

Like 
  
Equitymaster requests your view! Post a comment on "Why Are Stock Markets Worried about Low Oil Prices?". Click here!
DISCLOSURES UNDER SEBI (RESEARCH ANALYSTS) REGULATIONS, 2014
INTRODUCTION:
Equitymaster Agora Research Private Limited (hereinafter referred to as "Equitymaster"/"Company") was incorporated on October 25, 2007. Equitymaster is a joint venture between Quantum Information Services Private Limited (QIS) and Agora group. Equitymaster is a SEBI registered Research Analyst under the SEBI (Research Analysts) Regulations, 2014 with registration number INH000000537.

BUSINESS ACTIVITY:
An independent research initiative, Equitymaster is committed to providing honest and unbiased views, opinions and recommendations on various investment opportunities across asset classes.

DISCIPLINARY HISTORY:
There are no outstanding litigations against the Company, it subsidiaries and its Directors.

GENERAL TERMS AND CONDITIONS FOR RESEARCH REPORT:
For the terms and conditions for research reports click here.

DETAILS OF ASSOCIATES:
Details of Associates are available here.

DISCLOSURE WITH REGARDS TO OWNERSHIP AND MATERIAL CONFLICTS OF INTEREST:
  1. 'subject company' is a company on which a buy/sell/hold view or target price is given/changed in this Research Report
  2. Neither Equitymaster, it's Associates, Research Analyst or his/her relative have any financial interest in the subject company.
  3. Neither Equitymaster, it's Associates, Research Analyst or his/her relative have actual/beneficial ownership of one percent or more securities of the subject company at the end of the month immediately preceding the date of publication of the research report.
  4. Neither Equitymaster, it's Associates, Research Analyst or his/her relative have any other material conflict of interest at the time of publication of the research report.
DISCLOSURE WITH REGARDS TO RECEIPT OF COMPENSATION:
  1. Neither Equitymaster nor it's Associates have received any compensation from the subject company in the past twelve months.
  2. Neither Equitymaster nor it's Associates have managed or co-managed public offering of securities for the subject company in the past twelve months.
  3. Neither Equitymaster nor it's Associates have received any compensation for investment banking or merchant banking or brokerage services from the subject company in the past twelve months.
  4. Neither Equitymaster nor it's Associates have received any compensation for products or services other than investment banking or merchant banking or brokerage services from the subject company in the past twelve months.
  5. Neither Equitymaster nor it's Associates have received any compensation or other benefits from the subject company or third party in connection with the research report.
GENERAL DISCLOSURES:
  1. The Research Analyst has not served as an officer, director or employee of the subject company.
  2. Equitymaster or the Research Analyst has not been engaged in market making activity for the subject company.
Definitions of Terms Used:
  1. Buy recommendation: This means that the investor could consider buying the concerned stock at current market price keeping in mind the tenure and objective of the recommendation service.
  2. Hold recommendation: This means that the investor could consider holding on to the shares of the company until further update and not buy more of the stock at current market price.
  3. Buy at lower price: This means that the investor should wait for some correction in the market price so that the stock can be bought at more attractive valuations keeping in mind the tenure and the objective of the service.
  4. Sell recommendation: This means that the investor could consider selling the stock at current market price keeping in mind the objective of the recommendation service.
Feedback:
If you have any feedback or query or wish to report a matter, please do not hesitate to write to us.