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Low oil prices rock the global stock market
This past week we saw a lot of madness. It started last Tuesday our time with the US Presidential debates and I think anything that stars with Donald Trump as a possible leader of the free world borders on the insane.
Then we were in the hands of the cutthroats of OPEC (Organization of the Petroleum Exporting Countries) and their oil-producing rivals – Iran, Russia and others outside of OPEC. And then we learnt that one of greatest banks in the world – Deutsche Bank – was in financial trouble!
Also read: Is Australia set for years of low rates?
Did I say we’ve seen some madness this week?
All eyes on oil
There are times when the mad money world doesn’t even make sense to an economist and there’s no better example than when it comes to oil.
Ahead of the oil meeting in Algiers earlier this week I put the get-together into context.
I said right now, we’re facing either rising oil prices or an ‘Oilmaggedon’, where they slump like a poorly made soufflé.
If the meeting fails it won’t be a nice fall in the price of a key input into worldwide production, which should bring down inflation and improve the profitability of businesses, creating a huge increase in the demand for workers and thereby reducing unemployment.
How oil prices impacts the stock markets
Of course, that’s what lower oil prices should mean. It should be a good thing, except for our buddies in oil producing countries, who have held the world to ransom on many occasions. But how come stock markets nowadays see lower oil prices in a different light?
CNBC this week ran with this headline: “Dow briefly jumps 100 points after OPEC reportedly reaches an output deal.”
When the oil producers go their own way oil prices fall and earlier not long ago they fell from $US60 a barrel to a low of about $US28 and some ‘experts’ talked about $US15, which would have been ‘Oilmageddon’!
Also read: The recessionary horror of the Western Australian economy
Don’t mention the R word!
This coincided with exaggerated fears that the world was looking at another recession and stock markets didn’t like what they heard. Our stock market, measured by the S&P/ASX 200 index, went as low as 4707 but is now around 5400, so that’s about a 700-point gain. And over that time, oil has risen to around $US46 a barrel, which is a 64% gain!
The US stock market has gone up about 20% and at the core of this comeback has been the recovery in the price of oil!
Domino effect
Despite all the worldwide income and cost benefits of a lower oil price, the dislocation effect of too low an oil price rocked the stock market. I’m talking about businesses in energy and all the related businesses that supply and work with energy businesses from transport to engineering to even white collar services. All of them were beaten up on the stock market as expert analysts calculated the knock-on effect if big energy companies were making big losses, thanks to a lower oil price.
We are energy-dependent and oil is still the big kahuna in this space. And that’s why this reported OPEC agreement – yes they agreed! – means so much to stock markets.
Also read: Some Aussie property markets correcting, others booming
What would a Trump Presidency mean?
Okay, so we’ve got over this oil madness with an apparent deal to cut production but these guys do meet again in November and I suspect it’s to see what happens in the US election.
The mad possibility of a President Donald Trump would hurt financial markets and it might mean an oil deal would be more compelling, based on the fact that the global economy would be a big chance for a recession, if oil prices slumped in concert with a ‘Trump-slumped’ stock market!
Reality bites
I could be reading too much care for the world economy into this oil agreement but my argument is a valid one, as oil producers need economically healthy customers to sell to and a recession would hurt them severely.
I’d love lower oil prices as an economist – it should deliver income, jobs and lower costs – but in the real world, it scares the you know what out of financial markets!
This is why I often talk about mad money markets, though as you can see, there’s method in their madness.
Not the Germans too!
And if OPEC and Donald were not madness enough we now learn that Deutsche Bank is in trouble and the German Government and the bank’s leadership team are telling the market stuff that has seen its share price go south, big time. Have a look at this chart:
Tough times for Deutsche Bank
So how bad is this? This from www.market.watch.com shows why I’m adding this to my mad things of the week: “Excessive leverage is at the heart of Deutsche Bank’s woes. The lender’s leverage ratio—total assets to shareholder equity – is estimated to be north of 40-to-1… To put that into perspective, Lehman Brothers had a leverage ratio of 30.7 to 1 in 2007, according to a Yale University review of the investment bank’s September 15 bankruptcy.”
I really hope really smart people are working on this challenge to the world financial system. If they are not, it would be criminal madness!
Peter Switzer is the founder of the Switzer Super Report, a newsletter and website for self-managed super funds.
