On Monday, risk assets reacted poorly to the dramatic events that unfolded over the weekend in Saudi Arabia, where drone attacks on the country’s oil infrastructure took half of the kingdom’s production capacity offline.
Brent spiked ~$12 out of the gate to start the new week, the biggest intraday jump on record.
The US and the Saudis blamed Tehran, and the prospect of retaliatory strikes spooked investors at a time when geopolitical risk continues to dominate headlines, even on days when that risk isn’t reflected in the price action.
Read more: Saudis Say ‘Investigation’ Shows Iranian Weapons Used In Aramco Attacks
As doubts continued to swirl around the timeline on Aramco fully restoring capacity, crude rebuilt gains, rising 14%.
What does this presage for equities going forward? The Saudis will eventually bring production back to normal levels, but it’s probably safe to assume the market will henceforth incorporate a geopolitical risk premium to account for the possibility of more strikes against the kingdom. Assuming that leaves prices sustainably higher, how should we expect the S&P to react? Or, put differently, where is the break-even point when rising oil begins to hurt stocks?
JPMorgan’s Marko Kolanovic has done the math.
“Generally, oil positively correlates with S&P 500 when oil prices are stable [but] for large % increases in oil, this correlations weakens, and eventually turns negative”, he writes, in a note dated Monday.
The historical correlation suggests that the threshold beyond which rising WTI prices begin to exert a negative influence on US equities is well above current levels, even accounting for Monday’s epic spike.
“We could start expecting a negative impact from oil on the S&P 500 in an $80-$85 range for WTI”, Kolanovic says, adding that “in addition to historical quantitative analysis, current macro fundamentals and global trade tensions may also play a role”.
Will we get there? Well, it’s too early to make that kind of call, although it’s worth noting that on Monday afternoon, sources said Aramco officials are worried that restoring production might take longer than expected.
On the bright side, Kolanovic thinks “elevated geopolitical risks in the Middle East and rising oil prices may incentivize both China and US to reach a timely trade agreement”.
I think it’s more than just ‘elevated geopolitical risk’. If Mr. Bone Saw is willing to chop up a US resident in an embassy of a NATO country while his fiance stands outside because he was saying mean things than there is zero percent chance that he is not going to be striking back at Iran in a big way for blowing up his Aramco IPO. Just a matter of when.
I think your analyst is making an error….. he is doing 1st level thinking here. A 12% rise in oil prices is a significant hit to developing asia outside of perhaps indonesia and vietnam. China and Japan really take a whack as well. The second and third order effects here are probably significant if oil risk premiums persist. The geopolitical ramifications are serious. I don’t see how Kolanovic would conclude that this leads to a higher likelihood of a trade deal with China either. It might, but I don’t see what basis he would have for coming to that conclusion. It could just as easily force both leaders to play to their nationalistic hardline political bases.
The domestic US relationship with oil prices has changed greatly in the past decade. As the largest producer and largest exporter, the US now benefits from high oil prices as much as it suffers.
Beneficiaries of high prices are TX, OK, E&P, HY issuers and holders, etc. Sufferers are drivers, transport, and a broad but diffuse impact on “the consumer”.
I think that as a practical matter, oil prices are no longer a major driving factor for the US economy overall unless the price gets extreme. $30 is extreme, $130 too. But a move from $50 to $80 and back to $50, while interesting for energy stocks, isn’t a big deal overall.
Ria’s point, that rising oil prices still have clearly negative impacts on other countries, bears watching.
It has been a long time since you could watch falling (rising) oil prices and expect tradable positive (negative) impacts on, say, retail stocks.