Stupid question about Oil

BS I ain’t trying to beef witchu. We gotta agree to disagree. I know you’re on the buyside now so you live and breath market sentiment day in and day out, while I, as you correctly identified, do not. To each their own. How is the buyside gig going?

“There are two kinds of investors, be they large or small: those who don’t know where the market is headed, and those who don’t know that they don’t know. Then again, there is a third type of investor - the investment professional, who indeed knows that he or she doesn’t know, but whose livelihood depends upon appearing to know.” - Bernstein, William

Thanks for the responses.

Although I could be wrong, I do get the impression that the selloff in equities is a reaction to energy prices, and is not solely coincidental to the economy slowing down. It is most likely, as people suggest, a combination of economic perturbations and increased volatility causing people to take money out of risky assets. US economic data has been good throughout this volatile period, if that matters.

I suppose if someone were to discover an infinite free energy source tomorrow, economic turmoil in energy producing regions (let’s say Russia goes bankrupt) would cause a contagious recession in other parts of the world. In the short term, I can see how this would be bad for the world economy, even if the long term effects are positive.

On the topic of “randomness”, I agree that it would have been hard, earlier in this year, to have forecasted $60 oil. However, that’s not the original question, which is why this oil price decline affects other assets like it does. There is almost certainly a rational explanation for the original question.

It’s going well.

I really think you’re not understanding what’s being discussed. AGAIN, I’m not talking about forecasting. I’m talking about understanding the effects of events on companies. A tsuname impacts an insurance company and outlook for nuclear investment. So stock price falls, the tsunami is random, the relationship is not.

To be completely clear. I’m not saying that I could have told you whether oil or stocks would go up or down today. But if you told me oil was going down, I could have rightly predicted that stocks would go down.

“Efficient market theory is a wonderful economic doctrine that had a long vogue in spite of the experience of Berkshire Hathaway. In fact one of the economists who won — he shared a Nobel Prize — and as he looked at Berkshire Hathaway year after year, which people would throw in his face as saying maybe the market isn’t quite as efficient as you think, he said, “Well, it’s a two-sigma event.” And then he said we were a three-sigma event. And then he said we were a four-sigma event. And he finally got up to six sigmas — better to add a sigma than change a theory, just because the evidence comes in differently. [Laughter] And, of course, when this share of a Nobel Prize went into money management himself, he sank like a stone.” - Charlie Munger

I’m pretty sure in Black Swan he does say that, for the same reasons CvM has elloborated above. I don’t have a digital copy or I’d search to confirm, since its been several years since I’ve read.

I follow the market pretty closely for someone who doesn’t do that for my job. That being said, all the analysts telling you now why oil dropped had price targets of 150 just four months ago. I don’t think one should ignore the world, but there is a difference between figuring out long term trends and these short term movements the media focuses on and assigns narratives to.

Ok, I’ve read the book like 4 times, fooled by randomness even more times and I’m working through anti-fragile again right now so I can tell you he doesn’t say that. He does say large random events dominate market returns and that we reverse engineer narratives to make them seem more probable than they were and that prediction is a difficult business and that any attempt at prediction using stastical means, particularly historical data sets will be doomed to failure. He does not say that the actual chain of events was actaully random or that causality does not exist.

Secondly, and I’m getting frustrated here. WE ARE NOT TALKING ABOUT PREDICTIONS OR SEQUENTIAL CAUSALITY FOR THE LOVE OF ALLAH.

Are people just not reading posts, messing with me, or actually this confused by simple principles?

No, people are this confused by principles.

Here’s a question, will lower prices lead to inflation or deflation?

Just to be clear, I’m not claiming to know the sequential time series effects.

But my guess would be that in a vacuum lower prices would initially drive deflation, because obviously prices are down and volume hasn’t had a chance to react yet. Then eventually it should drive inflation as the cost savings begin to function like a stimulus and velocity drive volume up. The problem here could come from the fact that Europe is going through a period of austerity and deleveraging that could more likely outweigh the effects of energy savings and prevent velocity from increasing. So you could just see more deflation in that market because any savings would just be passed on to debt paydown.

You can put me in this camp. Over the short run, the market usually doesn’t know up from down. Over time it generally gets it right, at least in invidual equities.

Back in late 2004/ early 2005, when oil was going from $30 to $70, the opposite was happening to the equity market. For every uptick in oil, there was a downtick in the equity market. Then the relationship broke 6 months later.

Nobody said it’s permanent or a law.

But there were definitely some differences back then… aircraft manufacturers weren’t banking on release of next gen fuel efficient but composite heavy and redesigned airliners launching in 2016 to fill their backlogs. Rails hadn’t invested heavily in CAPEX to ship shale oil, and the whole fracking industry was barely a blip. Europe wasn’t in a crisis and we weren’t concerned about the bottom falling out on China or how Australia will handle a prolonged mining crisis, the USGC petro chem industry hadn’t built itself around LNG, etc.

Basically, times were different.

I’d tend to side with CvM in this discussion. I see a lot of people who were not even forecasting oil would drop below $100 in the summer now offering all kind of rationalizations as to why it has occurred. The fact is, in the short term at least, much/most market movements are random.

Well since the question was “why are equity markets down?” and not “what’s with oil forecasts?”, or “why’s oil down?”, thanks for answering the question no one asked!

So if in a few months oil and equity markets are still down will that be enough for all the “it’s random” people to change their mind?

IMO there is no simple answer to this whole issue, obviously.

Main catalysts are slowing demand globally + OPEC decision. That’s the rational part ; what is happening now is certainly not random.

Then there is the overreaction component ; people are freaking out and taking down equities.

The current price movements in equities obviously don’t recognise the fact that low oil prices are good for consumption and industrial activities in diversified economies (which Alberta, for one, is not).

So currently, one type of pressure is prevailing. In one month, it might be another.

Prices are the result of many antagonising factors. On the short-term, inflections can happen that don’t make much sense and that appear random, even if individually, each and every antagonising factor is explainable.

black swan makes a good point. sharp drop could lead to contagion, ie defaults in smaller companies leading to larger defaults. low oil prices is prolly a explanation of lower global gdp, there is trouble in europe and a slow down in china, which affects all emerging markets. But this is all cyclical. Demand will pick up.

On the supply side, US has a ton of shale. and im pretty sure so does the entire world, they juss dont have the tools to monetize it. I saw a map before from space showing all the lights from oil companies and you see it shing brightly all around texas then complete darkness in mexico. literally this is the world. its a secular shift. Gas is more plentiful than people expect and oil prices could remain low.

But net net, if oil prices are low then the weakest companies will flop, thereby reducing supply. (or countries, russia prolly getting killed) Oil prices will not stay low forever. They usually recover with 3 mo’s. Assuming this month counts, i give it 2 to recover. By end of 2015, i am pretty sure oil will be ridiculously higher than 60. the cost of oil production sets a floor on the price and that average globally right now is at 60 to 65.

And on oil not helping out companies. I can tell you several stocks that have recently increased their guidance over 5% citing lower oil prices. I can tell you some oil companies that have stopped hedging recently cuz they are forecasting a rebound.

And as far as random walk. I dont ascribe to it. When you look at history, it has a pretty good explanation. the problem is in the current timeframe, people do not see the full picture yet. the more you read, the more you know. Listen to people who are experts. ie hacksaw rule. and make sure they put/keep their money where their mouth is. people are prolly going to say hindsight bias, but history repeats itself. btw love the bernstein quote cvm. that was in howard marks thing.

Dang it. I had a really good response to the OP’s question, but the internet collapsed and my response went with it.

But if I understand OP’s question, he says “Why is a decline in the price of oil lead to a decline in the market indices? Lower oil = lower energy prices, which should be good for the economy (unless you’re in the business of selling oil, that is).”

I think he misunderestimates exactly how much impact the oil boom has had on the national economy. Obviously I feel it in West Texas, but it also reaches into New Mexico, Oklahoma, Louisiana, South Texas, North Texas, Louisiana, North Dakota, Wyoming, Colorado, Utah, western New York, Pennsylvania, Ohio, West Virginia, California, and Michigan. (Yes, there is oil production in CA and MI, although most companies won’t operate there, because it’s such a PITA to get around the bleeding heart environmentalists and government red tape.)

And even in non-oil-producing areas, people are still working for oil companies. There are people who drive from St. Louis, Missouri to Alva, Oklahoma to drive trucks for service companies. They work for two weeks, sleep in their car, then they drive back to St. Louis to see their families. That’s right–they drive 550 miles, one-way, to work, because it pays better than the work they can get back in St. Louis.

So in much of the US, the oil boom has led to lower unemployment, higher wages, and has made a lot of millionaires out of the mineral rights owners through royalty payments. And (as tautological as this is) when people have money, they spend it. I believe the oil boom is largely responsible for the recovery of the US economy.

And conversely, when people don’t have money, they don’t spend it. And with a lot of oil companies slowing down or even cutting off exploration, there will be no more money. No more truck driving, no more rig hands, no more royalty payments, no rigs being built or moved, etc. This will have a ripple effect to other areas not associated with oil, simply because the revenue stream won’t be there.

So to sum it up, lower energy prices are good for users of energy, but unless there’s another industry that can absorb the job losses and replace the lost revenue stream, then the bad will outweigh the good.


(p.s. This is not exactly a well-thought out research report or scientific analysis, it’s more me thinking out loud. I say a lot of this with absolutely no evidence whatsoever.)

(p.p.s. I haven’t read the whole thread, I just read the first post. Sorry if I duplicated somebody else’s answer.)

I just went long Commodities.

The oil price fall really was a bit of a black swan. If you polled professional investors in June and asked what the likelyhood you’d see sub $60 oil in the next 6 months most people would have considered it a multiple standard deviation event.

In terms of why the market is down with oil, I think this thread is evidence of the fact that there is no one reason. I can make up lots of different narratives for why the market sold over the last week with oil, but bottom line I believe it is emotional, panick selling. As I stated previously, Nasdaq was down more than Dow yesterday and today.

I agree with Greenman, and not just because I’m a Texan who sees oil production everywhere.

Domestic energy production has been a big driver of the improving employment situation. Some if not most of those jobs are contract based. That’s the biggest threat of contagion in my opinion. Lower employment, lower consumption, lower GDP growth, lower inflation.

Then again, I’m not too worried about it because the other 2/3 of the 3 major developed economies are back on QE, and that makes it easier for the US to do the same.