Kevin Rosenbaum
Answers to our clients’ questions about market action and the market environment in a few paragraphs every two weeks.
No. Although crude oil prices above $100* a barrel will pinch consumer pockets, investor anxiety on this topic is both premature and exaggerated.
To be sure, the rally in oil prices has been impressive. Since the bottom of the energy commodity downturn in first quarter 2016, the cost of Brent crude has tripled to $84 a barrel. This rise came as producers curtailed investment in new wells to a greater extent than ever before and as global demand grew at an above-average pace. In recent weeks, prices have reacted to data indicating Iranian exports have dropped more than expected, due to buyers looking to comply with a US sanctions deadline in November. This, in combination with concerns about Venezuela’s plummeting oil production, has led to renewed speculation on whether other OPEC member countries and Russia could easily offset a global shortfall.
Still, fearing a $100 barrel is premature. Crossing that threshold this quarter would imply at least a 21% jump in Brent crude prices. A quarterly increase of that magnitude for oil is rare, occurring just 15 times in the 30 years of existing data. And, of those 15, only a few followed periods of strong performance similar to what markets have experienced recently. Beyond the historical record, the US government forecasts that global supply will outstrip demand next year, adding to existing oil inventories and putting downward pressure on prices. Indeed, no bank or research house is currently forecasting $100 oil this year or next, at least according to forecasts available on Bloomberg.
Of course, what are forecasts for if not to be wrong? Assuming oil prices climb to $100 a barrel, a greater share of household income would be needed to buy the same amount of petroleum products, all else equal. Businesses, too, would be impacted, not least because transportation costs would rise. But the hit to growth isn’t what TV pundits frequently suggest. In the history of Brent crude, there are only 19 quarters when inflation-adjusted prices averaged above $100 a barrel. During those quarters, global GDP grew at an average annual pace of 2.6%. This is a respectable result, considering global GDP has grown only at a 3.0% clip when prices averaged below $100.
Equity markets have also held up well. Using the MSCI All Country World Index as a global proxy, equity markets returned 0.5%, on average, across the 19 high oil price quarters. This result, compared to the 2.5% equity markets returned in all other quarters, leaves much to be desired at first glance. But, the quarters with high oil prices coincided with two of the worst quarterly market performances in history—the start of the global financial crisis in third quarter 2008 (-16.5%) and the start of the sovereign debt panic in third quarter 2011 (-17.3%), neither of which were linked to oil prices. Excluding those two quarters, equity markets have slightly outperformed in high oil price environments.
But the resilience of global equity markets in broad terms does mask dispersion. High oil price environments have challenged many developing countries, with the MSCI Emerging Markets Index returning just 1.0% per quarter, on average. This result, which excludes the disastrous two quarters mentioned previously and coincides with strengthening USD conditions, lagged its average finish across all other quarters by just over 300 basis points. Heavyweights China, Korea, and Taiwan, which collectively make up roughly 60% of the index’s current market capitalization and are all net importers of oil, all fell victim to this pattern of underperformance.
All this is not to say that investors should welcome $100 oil. To the contrary, a high oil price will no doubt be more of a drag on global growth and asset performance than a low oil price, all else equal. Yet, investor fears of $100 oil are both premature and exaggerated, as markets are rarely responsive to changes in just one variable. Instead, markets reflect the health of a multitude of variables, whose interdependence vary through time. When high oil prices occur alongside other prominent warning signs, then investors should pay close attention.
* All prices and returns are in USD terms.
Kevin Rosenbaum, Deputy Head of Cambridge Associates’ Capital Markets Research