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.
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”.