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July 10, 2017 at 08:00 PM
If oil prices keep falling they could sound the death knell of the stock market rally, now in its ninth year, according to Gary Shilling, president of A. Gary Shilling & Co., an economic research and money management firm.
In that case, “financial worries will no doubt magnify, and the result could be the shock we’ve been looking for that would end the long bull market in stocks that started in March 2009 and precipitate a recession,” writes Shilling in his latest monthly economic research and strategy report.
(Related: Equities Are Overvalued, Many Investors in Merrill Survey Say)
Shilling expects oil prices will eventually fall to $10 to $20 a barrel, which “would be a financial shock reminiscent of the dot-com collapse in the late 1990s that precipitated the 2001 recession. It would also resemble the subprime mortgage debacle in the mid-2000s that touched off the 2007-2009 Great Recession, the deepest since the 1930s.”
(Related: Investor Optimism Stalls: Wells Fargo/Gallup Survey)
But why are lower oil prices bad for stocks? The conventional wisdom has been just the opposite, that lower oil prices support stocks because they put more money into consumers’ pockets to spend on goods and services, which would boost corporate revenues and earnings.
“The relationship between oil and stocks has changed,” Shilling tells ThinkAdvisor. Since 2014, when OPEC declined to cut production, the S&P 500 has tended to rise as oil prices climb and fall when oil prices decline, according to Shilling.
That’s due in part to the declining share of oil stocks in the Standard & Poor’s 500 index, down to 6% from 16% in 2008, says Shilling. “Seven of the 10 worst-performing stocks in the S&P 500 index this year are in the energy sector.”
In addition, investors may be more focused on the negative effects of lower oil prices, namely that the financial problems of highly leveraged energy companies due to lower oil prices could spread beyond that sector, writes Shilling.
