Oil recently entered a bear market, and most traders are spending their time figuring out the implications for the energy sector.
In the old days, people used to say that copper had a PhD in economics. I don’t think that’s as true as it once was–the market for base metals is frequently distorted by speculative activity from China. Oil, on the other hand, is turning into an indicator of overall economic health.
Remember years ago, when stocks would rally when oil went down? Now, the opposite is true–oil goes down, and stocks go down, too.
A lot of people attribute that to a decline in investment in the energy sector, and more importantly, possible contagion effects from plummeting high yield energy credits. But it’s bigger than that. We learned in 2008 that people should spend less time focusing on the supply side in oil, and more time on the demand side. I think the recent slide in oil prices is forecasting a recession–which might happen soon.
The economic data doesn’t show a recession in the near future–at least, if you’re looking at lagging indicators such as unemployment. But auto loans are falling apart–a leading indicator if there ever was one–and consumer credit overall looks pretty bad. The yield curve is flattening hard, though usually nobody pays any attention to that until it completlely flattens or inverts. With short rates so low, a slightly steep yield curve may be a recession indicator, too.
Most people agree that we are towards the end of a very long expansion. Nobody agrees on whether a recession is imminent, or what it would look like. Certainly there is a lot of evidence of speculative activity. Some stock market bears think that a decline of 50% is possible. I think that’s unlikely, but based on valuations, it’s not entirely unreasonable.
Oil prices are also a huge input in the Canadian economy, of course, which makes the Bank of Canada’s sudden quest to hike interest rates seem somewhat quixotic.
If I look around the world at vulnerabilities–known colloquially as the “point of maximum pain”–it seems like the scenario where everyone loses is $30/barrel or below. It would crush the United States and Canada. It would founder the Aramco IPO. It would make the Middle East more unstable, and it would make Russia more unstable. Everyone loses–except consumers. People have already forgotten the pandemonium that happened in high yield the last time oil got below $30. It prompted Carl Icahn to release a video saying that the bond market was going to blow up the world.
Crude oil prices are the “tell” for the global markets. After sliding into a bear market, nobody seems to be squealing–yet. The last time oil prices got this low, low prices encouraged more production, which led to even lower prices, in a vicious feedback loop. It would not surprise me to see the same thing happen a second time.