Figure out the direction of oil prices and you can probably figure out where the economy and stocks are going in the second half — but not the way you think.
It’s normal to think lower oil prices will help the economy and boost prices. But the reality is that the stock market has followed oil prices in the past year and more. When oil has gone up, stocks have gone up; when oil has faltered, so have stocks — strange, but true.
That’s why it’s valuable to know that oil prices probably overreacted by falling sharply after the International Energy Agency decided last week to release emergency stockpiles, taking stocks down with them (Prices jumped higher on Tuesday to three-week highs).
The IEA will release up to 60 million barrels of oil over the next 30 days, or 2 million barrels a day. That sounds like a lot but it is not nearly enough to change the supply/demand balance.
Countries that are members of the IA have nearly 1.6 billion barrels of oil in inventory held for emergencies. Capital Economics analysts point out that they could release 2 million barrels a day for more than two years.
Yet, oil analysts around the world slashed oil price forecasts. The more likely reason that prices were pushed down were that traders recognize that world governments want to stick a finger in the eye of OPEC and curb speculation. Governments have a lot of tools at their disposal, and they are starting to use them. They raised futures margin requirements, they are releasing more oil, and they have other tricks. If they want to push down prices, they can do it.
The main thing that falling oil prices does is ease fears that inflation is about to take off, which should help government bonds — pretty clever, coming at a time when sovereign debt is under pressure. Investors should figure that’s at least part of the rationale.