Weekly Wire – The Oil Slick That Stocks Are On
Historically, oil prices and the US Stock market are not highly correlated. Meaning, when one goes up or down that does not necessarily signify the other is going to follow suit. However, right now, we are definitely seeing more of a connection between the two.
Over the weekend, OPEC met in Doha, the capital of the peninsular Persian (Arabian) Gulf country Qatar. The goal was to set a production freeze in order to keep prices from falling too much because of increased supply levels. For several reasons, the talks failed to produce a freeze therefore production continues and oil prices continue to fall.
At the pump we all like lower gas prices, no question about that. We can’t recall ever hearing someone say, “I wish this gas was a bit more expensive”. So why are the equities markets so nervous about something consumers like?
This is an oversimplification, but in a nutshell, oil is big business that has a large debt load with financial institutions globally. Financial institutions are also big business. If the profits from oil drop too low, the companies that rely on oil profits experience a diminished profit and may end up being unable to pay back their debt to the financial institutions. As a result, two very large sectors suffer and the related stock markets take a hit.
In one of our recent Weekly Wires we asked: Does it make sense to total the car over a flat tire? The answer is “no”. Taking a complete defensive approach to all equity holdings based solely on the falling price of oil may be akin to totaling the car. However, being selectively defensive using a sector rotation strategy may not be a bad idea.
For now, our advice is to enjoy the low prices at the pump, but realize those great prices may be signaling a change in sector leadership in your portfolio.