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News & Blog

Do Declining Oil Prices Affect Equities…?

Posted: 22nd October 2014

BARCLAYS_COL 300dpiCrude oil’s precipitous decline since the end of June is important for many reasons, but not necessarily the ones that some market observers are currently fretting over. Commodities in general have been poor this year, but oil has been particularly weak since the summer, with Brent Crude falling over 20%. Many suspect that commodity markets ‘know something’ about global growth that bond markets have long hinted at and equity markets are only just waking up to. We suspect this view risks underplaying the effects of a rising US dollar on an asset class predominately quoted in dollars, but, more importantly, the fact that prices are not just a function of demand, but also supply.

With regard to oil in particular, figures released last Friday showed OPEC lifted output in September by the largest amount in almost three years. The US supply story is also no doubt instrumental in oil’s continued retreat, as are continued efficiencies with regards to utilisation. In the words of the famous former Saudi oil minister, Sheikh Zaki Yamani “the stone age didn’t end for lack of stone…”

Even if we do not see the recent decline in the oil price as particularly sinister with regard to the prospects for global growth, it does have important ramifications for equity markets. Companies reliant on energy prices rises for revenue growth tend to outweigh those either agnostic to, or benefiting from, falling oil prices in most equity indices. With oil prices now moving towards widely suspected thresholds for Saudi Arabia’s fiscal balance, we suspect further downside should be capped given the kingdom’s role as the marginal supplier in a global oil market.

What about the rising dollar…?

 

Amidst all the concerns about the likely affect of a rising dollar on the prospects for the US economy, one often neglected point is its historic influence on the amount that investors are willing to pay for a dollar, euro or pound of quoted corporate sector earnings. There is a strong relationship between a rising dollar and the price earnings ratio of US and global ex-US equity indices.

 

Intuitively this makes sense. More often than not a rising US dollar is a symptom of robust health in the world’s largest and most important capitalist economy. Most of the time, this suggests that the prospects for global growth will, in varying lags, follow suit. In such an environment, investors should be willing to pay more for the earnings of the quoted corporate sector.

Business Comment

Business Comment is the Edinburgh Chamber of Commerce’s bi-monthly magazine. It provides insight on Edinburgh’s vibrant business community, with features on the city’s key sectors, interviews with leading figures and news on new business developments in the capital.
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