Do Oil Price Spikes Cause Recessions?

Includes: NE, OIL
by: Kevin McElroy

Okay, I have to admit, I didn’t come up with the theory that major recessions are, in part, caused by spikes in the price of oil. The idea as I originally heard it comes from Jeff Rubin, an energy analyst and former Canadian investment banker. I heard Mr. Rubin give a very entertaining, informative and altogether depressing speech about the ramifications of triple digit oil.

And since we’re on the eve of that precipice, with oil tug-of-warring with $90 a barrel, I think it’s important to look at this bold and somewhat confusing notion that spikes in the price of oil are so disruptive and destructive to the marketplace as to actually be one of the sole causes of recessions in the past 40 years.

It’s quite likely that he discovered this notion from someone else, and that even more people have found it by themselves. Because it really doesn’t take too much digging in to the brief history of oil prices to have the obvious stare you in the face. Take a look at the chart below which shows oil prices over the past 40 years:

You’ll note significant moves upwards in the price of oil in 1973-74, 1979-1980, 1990, 1999-2000, and 2004-2008. I guess it’s kind of redundant, but all of those time periods slightly preceded significant stock market recessions.

It’s also worth pointing out that the times the price of oil dropped preceded some of the strongest periods of stock market strength in the American economy: 1986, 1997, 2002 and 2009. I won’t speak to the specifics of GDP before, during and after these periods, because I think the trend is painfully obvious without drilling too deep into the numbers for confirmation.

So, the question is: what can we do with this information?

It’s not helpful to simply point out obvious problems and walk away. Before I tell you what I think you should do – I want you to really think about the disastrous effects that oil price spikes have had on the average portfolio. Maybe you were wiped out in 2000 or 2008. Maybe you lost it all in the recession of 1979-81 – heck, maybe you lost your job. I guess my point is that we know two things for certain about oil and its effect on the economy:

  1. Oil tends to send the stock market screaming lower when the price spikes.
  2. There’s very little keeping the price of oil below the $100 mark and keeping it from skyrocketing at any time in the next 6-18 months.

That being said, I guess my main solution would be align your portfolio with companies that are likely to profit when (not if) prices spike precipitously higher. I’ve talked about owning one sector of companies to achieve this feat: oil services companies.

My favorite company to play this trend?

It’s still Noble Corp. (NYSE:NE). This company still sells for less than 8 times earnings. Moreover, this company has barely played along with the overwhelming run-up in the broad market over the past six months. I think it could be the perfect time to build or add to a position in this company –who knows when oil will take off?

Disclosure: No positions