Walls Of Worry Update

by: Calafia Beach Pundit

The equity market is now in the midst of what looks like another wall of worry. The last wall of worry was all about Ebola, while this time around the market is worried about the collapse in the price of oil-down almost 50% since last June-and how that is affecting major oil producers, notably Russia, whose currency has lost about 50% of its value over the same period. This all amounts to a tremendous amount of change in a relatively short period, and that's enough to make anyone nervous.

As the chart above shows, the ratio of the Vix index to the 10-yr Treasury yield (a proxy for fear and uncertainty) has spiked almost as much as it did during the height of the Ebola panic. The equity market hasn't sold off quite as much yet, however, but it's not hard to imagine that the oil panic and surrounding uncertainty will take some time to digest.

Oil prices won't stop falling until producers cut back and/or consumers boost their oil consumption. That won't happen instantly, unfortunately. But there is little reason to think that prices are going to go down a black hole, and there's little reason to think that the world's oil consumers are going to decide to consume less now that oil is so much cheaper. It's easy for producers to halt new exploration, and it would seem that a halving of the price of oil ought to make a lot of wells unprofitable enough for their owners to shut down production, at least enough to chip away at the current oil glut.

I note that the world survived an even greater oil supply shock in 1986, when the price of crude fell from $29/bbl in early 1986 to $8/bbl by mid-1986. It then bounced back to $18 by the end of the year. Nevertheless, that was a collapse of over 70% in a six-month period, and the world didn't end. GDP growth slowed briefly to 2.1% in the second quarter of 1986, but went on to post 3% growth for the year. I also note that the U.S. economy today is far less dependent on oil than it was in 1986. Oil consumption per unit of output has declined by over 40% since 1986, in fact.