The price of oil has been a hot topic of virtually every market and economic conversation these days. The price of oil has clearly had an impact on the markets and economy. Even with this past Friday’s large one-day gain of 12%, crude oil prices are still down 80% from the 2014 high. In addition, stock and oil prices have been moving in the same proportion in the same direction often on a daily basis. Although stocks and oil have recently been trending together, stock prices do not typically experience near the extreme fluctuation as oil prices do. In general, oil has had roughly four times the volatility as stock prices. Volatility is the degree of variation of a trading price series over time as measured by the standard deviation of returns.
Recent research revealed extreme moves in oil is not as uncommon as it may seem. Every single decade going back to the 1980s has experienced a huge crash in the price of oil at one point during the decade. Below are the largest for each decade:
- 1980s: -67%
- 1990s: -72%
- 2000s: -76%
- 2010s: -80%
In general, cheaper oil should be a good thing for the economy. Energy price drops are often compared by economists with a tax cut, likely to boost consumer spending as people have more money in their pockets to spend in other areas. But in this type of market, fear of the unknown with energy prices and commodities is driving most of the market moves which negatively impacts the economy and stocks.
Nick Murray wrote a few years ago about the common myth that as stock prices fall, risk rises. The reality is that as stock prices fall, value rises. Similarly, there is a myth that as the current commodity cycle goes lower, America’s potential for the resumption of growth declines. Extreme movements in one direction means we are that much closer to a reversal in these trends. As illustrated in 2008-2009, we saw oil prices rapidly go from around $140 a barrel to under $45 a barrel and stocks drop by over 55%, setting the stage for the 2009-2014 recovery where oil advanced back up to $105 and the S&P went from 665 to over 2100.
It’s never pleasant to see your portfolio go down in value, even if it is temporary. Scientific research has proven that losses hurt twice as much as gains feel good. This is called loss aversion. Additionally, frequent monitoring of your investment performance amplifies this loss aversion effect and is when most behavioral mistakes are made, resulting in below average investment results. Constantly watching a portfolio’s daily performance leads to pain from seeing losses, which leads to even more frequent monitoring of performance. This is why many investor mistakes are made during market declines.
The current oil and stock market uncertainty is a great reminder of the importance of discipline. In the midst of a market downturn, we may be inclined to look for some type of signal as to what the recent period means for future returns or to assume the current period is somehow different from what we have observed historically. However, academic and historic evidence suggests prices adjust in such a way that every day there is a positive future expected return on our invested capital. While the realized return over any short-term period may be positive or negative, in expectation, markets will go up over time. As seen below, investors have been rewarded in past downturns and uncertainty by remaining disciplined to their plan:
As always, please don’t hesitate to reach out to us with any questions or concerns. We appreciate your continued trust and confidence in our firm.
Best always,
Your Castleview Team
“Past performance does not guarantee future results. Diversification does not eliminate the risk of market loss. General investment risks include loss of principal and fluctuating value. International investing involves special risks such as currency fluctuation and political instability. Data provided by Standard and Poor’s.”
Wall Street Journal: http://www.wsj.com/articles/oil-stocks-dance-the-bear-market-tango-1453722783
Nick Murray: http://www.nickmurraynewsletters.com/members/Clients-Corner-THE-AMAZING-DISAPPEARING-OIL-CRISIS-An-Object-Lesson.cfm
Ben Carlson: http://awealthofcommonsense.com/2016/01/correlations/
Dimensional Funds: https://my.dimensional.com/insight/special_postings/178068/