Are Rising Oil Prices Good For The Economy?

The ratio of Oil Stocks to Crude Oil Prices has been a good indicator of trends in the broader stock market. Since June this correlation has been breaking down with implications for both markets.

In a recent article on oil stocks we discussed why these stocks do not necessarily move in lock-step with the price of oil. In short, Oil Stocks are significant components of large stock indexes and as a result tend to move with the big averages regardless of the underlying oil price.

However, as soon as the price of Oil begins to head higher, economists become very nervous and fears of an inflationary shock ala 1973 resurface. Recent history has shown that a near 8 fold increase in the price of oil has not resulted in an outbreak of inflation, a recession or stock market collapse. In fact the stock market has surged higher during this same period which begs the question, are rising Oil prices good for the economy?

The answer, as we explained in the above article, is that if higher oil prices are accompanied by higher oil stock prices, the overall effect is positive for the economy and the broader stock market – the global growth theme. If the price of Oil is outperforming Oil Stocks this is perceived as inflationary and bad.

Hence we like to watch how this ratio performs to give us a clue of what to expect from the broader market.

Chart 1 - Oil Stock: Current Crude Oil Price ratio; Dow Industrials (blue)

By and large the oil stock: oil price ratio has been closely aligned with the Dow Jones Industrial average.

Current interpretation: The ratio made a double top in May 2007 [top green line] providing a warning that the stock market rally may soon be ending. Yet the stock market rallied into June causing us to question the usefulness of this ratio as a leading indicator.
The ratio continued dropping in June and July and broke below its February lows [lower green line] last week. Alongside this action the stock market has turned down ferociously.

Where to now?

I note that Oil prices have been rallying for nearly 7 weeks so they should be due for a rest. But the break below February lows is a sign that further out performance by the price of Crude versus Oil stocks is on the cards. The implication is that further stock market weakness lies ahead.

Take cover!

Comments

[Carl leason:]

Frankly, you are writing like a complete idiot ! Regardless of the "cost" of oil, higher gasoline prices are bad for the economy !!!! It takes money out of peoples pockets that they could use for other important things. I guess your opinion is that people can just eat hot dogs instead of a good meal, right ? It also forces people to cut back on spending in all areas just to be able to "fill the tank" ! You better find a new occupation ! LC

2007 Aug 09 11:48 AM

[Carl leason:]

Frankly, you are writing like a complete idiot ! Regardless of the "cost" of oil, higher gasoline prices are bad for the economy !!!! It takes money out of peoples pockets that they could use for other important things. I guess your opinion is that people can just eat hot dogs instead of a good meal, right ? It also forces people to cut back on spending in all areas just to be able to "fill the tank" ! You better find a new occupation ! LC

2007 Aug 09 11:48 AM

[Carl leason:]

Frankly, you are writing like a complete idiot ! Regardless of the "cost" of oil, higher gasoline prices are bad for the economy !!!! It takes money out of peoples pockets that they could use for other important things. I guess your opinion is that people can just eat hot dogs instead of a good meal, right ? It also forces people to cut back on spending in all areas just to be able to "fill the tank" ! You better find a new occupation ! LC

2007 Aug 09 11:49 AM

[Winston Kotzan:]

Is the tail wagging the dog? The reason oil is high during market rallies is because the economy is good and excess demand is driving up oil prices. You have the cause/effect inverse.

2007 Aug 09 03:44 PM

[Carl leason:]

I don't think I have it wrong,....
Think about it guy,...If you have more money in your pocket, good times or bad, you are probably going to spend it on things which will make the economy better,...more sales means everyone wins !
Take money out of my pocket for gas and I have less to spend on other things... Which makes the economy worse ! That's econ. 101 !!! If you make fuel really cheap, you have more to spend on "wants" rather than needs ! Want me to say it a few more times ?? A few different ways ??? LC

2007 Aug 09 07:00 PM