Why are Falling Oil Prices Bad for the Stock Market

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gouldnm
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Why are Falling Oil Prices Bad for the Stock Market

Post by gouldnm » Wed Dec 10, 2014 3:51 pm

As a person who grew up in the rust belt during the energy crisis in the early 70's and remembers how the rising cost of energy destroyed the U.S. economy, why are falling oil prices causing the stock market to crash? Why is this a bad thing? Could someone please explain this to me?

toto238
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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by toto238 » Wed Dec 10, 2014 4:00 pm

No matter what number moves in the economy, it's always good for someone and bad for someone else. That's the nature of economics. Most of the time, the good outweighs the bad by a fair bit. But there's always someone somewhere suffering.

1. Don't assume that low oil prices are hurting the stock market. They aren't. Or maybe they are. More than likely they're a factor, both positive and negative.
2. The common wisdom is that low oil prices are bad for oil companies, lowering the values of those companies, which lowers the values of the stock market
3. But low oil prices are great for many other companies, such as shipping companies, airlines, freight lines, grocery stores, your local Hummer dealership, etc.
4. Low oil prices also benefit all companies a bit as the cash freed up by lower prices at the pump leads consumers to purchase more of everything else

So low oil prices are hurting SOME stocks. But not all stocks.

Another thing to consider, though, is that low oil prices could be the symptom, not the disease. The disease could be weak demand in general. If demand for goods across the economy is falling, then demand for oil would fall as well, leading to lower oil prices. Perhaps it is that weak demand that is causing both oil prices and the stock market to go down.


In the end, it's all speculation. The stock market goes down 1% one day, then up 1% the next day. Oil goes up 5% in a day, then down 5% in a day. Why? As a very wise man once said, "Wibbly-wobbly, timey-wimey".

Everyone has a theory. It's all moot because they're all right, and they're all wrong. Everything is a factor and affecting oil prices. Which factors affect it more? Depends on who you're a lobbyist for.

Wagnerjb
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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by Wagnerjb » Wed Dec 10, 2014 4:02 pm

How can you be sure that falling prices are causing the stock market to decline? Could it be that a decline in the stock market is causing oil to fall?

As somebody who has worked in energy for 32 years, I am pretty sure that supply and demand is causing oil prices to drop. But I am less sure about what exactly is driving the stock market right now.

Best wishes.
Andy

scone
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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by scone » Wed Dec 10, 2014 4:17 pm

The stock market reacts to "new news," that is, surprises that have not already been "priced in." The drop in oil prices has been something of a surprise, to say the least. The energy sector companies are getting hit, as you might imagine. For that matter, any company or country that makes a living primarily off commodities is likely to get hit-- or at least that's what Mr. Market seems to think currently. So stocks are falling as the participants try to figure out the extent of the issue both here and overseas.

There may also be some year end profit taking going on. And general nerves. The herd is easily spooked.

Of course, the above is just a constructed narrative, with all the caveats appertaining thereto. In other words, it's just my opinion and worth what you paid for it.

Happy Holidays. :sharebeer
"My bond allocation is the amount of money that I cannot afford to lose." -- Taylor Larimore

tigermilk
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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by tigermilk » Wed Dec 10, 2014 4:22 pm

You have to look at supply/demand.

On the demand side, low prices means low demand, which can correlate to a slowing economy. What business, be it big oil, the companies that move that oil, or the Amazons of the world like a slowing economy? Stocks down pretty much across the board...

On the supply side, that's probably a bigger problem for those directly involved in production. No doubt you've heard how countries like Russia, Venezuela, and some of the OPEC nations need a certain price per barrel to support their budgets. Likewise, all that fracking and Canadian sand fields have a rock bottom price where it starts to hurt. If OPEC flooded the market with cheap oil, you and I are happy, the transporters are happy, but those that extract oil domestically are miserable. They can no longer support that work, lay off workers, long-term prospects dwindle, etc. Those oil-heavy index funds suffer.

If I take a quick peek at activity today, airline stocks are by and large up. Why not? Cheap gas is good! However, energy sector stocks are down, and not just the Shells and Exxons, but field operators like Schlumberger, Apache, etc.

The current supply/demand issue truly is two-fold and one of both supply and demand. OPEC says they won't cut production. I think they genuinely want to put the squeeze on non-OPEC oil producers. On the demand side, China has been slowing its demand, and a slow demand in China is tied to other economic issues which spooks many sectors.

thenextguy
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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by thenextguy » Wed Dec 10, 2014 4:27 pm

I believe that it's because it's introducing uncertainty into the market. It may end up not being a big deal, but people are still trying to make sense of this. What will the outcome be? Typically falling oil prices is good for the economy. And I suspect most traders still feel that way. There is, however, rumblings of a lot of US oil producers with high yield debt that could be under pressure now that oil has fallen so low. If these producers start defaulting, it could have a ripple effect. Still, I think the chances of that being a significant event are unlikely, which is probably why stocks are only struggling a little bit.

IMO...

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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by richard » Wed Dec 10, 2014 4:35 pm

toto238 wrote:<snip>Another thing to consider, though, is that low oil prices could be the symptom, not the disease. The disease could be weak demand in general. If demand for goods across the economy is falling, then demand for oil would fall as well, leading to lower oil prices. Perhaps it is that weak demand that is causing both oil prices and the stock market to go down.<>

That plus the Fed's apparent enthusiasm for tightening would be my best guess.

Trying to come up with rationales for day to day movements is not a productive activity (unless you're paid to do so).

EarlyStart
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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by EarlyStart » Wed Dec 10, 2014 5:26 pm

There is a broader concern that's not about only oil, but is (arguably) indicated by oil.


A lot of people believe that liquidity stimulus (like QE, expanding the money supply, etc) encourages and ultimately creates malinvestment/overproduction/whatever you want to call it. Ultimately the producers realize that they've made too much- the market doesn't demand that much, prices fall, blah, blah, blah.


So IF this were what is going on, it COULD be indicative of malinvestment and poor allocation of capital in a more general sense. There are only a hand full of bold claims about this, but people who trade more actively or have a short-run perspective may be getting a little more cautious.


I have no idea if that's what's going on. Ultimately it doesn't matter to me at all, but it's interesting regardless.

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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by Valuethinker » Wed Dec 10, 2014 6:39 pm

EarlyStart wrote:There is a broader concern that's not about only oil, but is (arguably) indicated by oil.


A lot of people believe that liquidity stimulus (like QE, expanding the money supply, etc) encourages and ultimately creates malinvestment/overproduction/whatever you want to call it. Ultimately the producers realize that they've made too much- the market doesn't demand that much, prices fall, blah, blah, blah.


Which would be a very strange line of argument.

There are 3 areas that have been unusually weak post recession in this economic cycle, compared to virtually every other post war recession:

- government employment (grew much more strongly post 2000 and earlier recessions except 1946 I believe)
- private housing (that may be changing, indeed there *are* signs of bubbles in some markets)
- investment by companies

Companies have been remarkably slow to make investments in new physical capital (plant, equipment and buildings) compared to previous recoveries.

So where, then, is this malinvestment/ overproduction? In 2000, yes, too much into Telecoms-Media-Tech, but this time?

Zecht
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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by Zecht » Wed Dec 10, 2014 6:46 pm

toto238 wrote:...In the end, it's all speculation. The stock market goes down 1% one day, then up 1% the next day. Oil goes up 5% in a day, then down 5% in a day. Why? As a very wise man once said, "Wibbly-wobbly, timey-wimey".


I'm glad I'm not the only person who quotes the Doctor as a legit response to questions.

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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by Valuethinker » Wed Dec 10, 2014 6:49 pm

gouldnm wrote:As a person who grew up in the rust belt during the energy crisis in the early 70's and remembers how the rising cost of energy destroyed the U.S. economy, why are falling oil prices causing the stock market to crash? Why is this a bad thing? Could someone please explain this to me?


It may have felt that way, but that was one of a complex set of causes. Some were structural, the 'emerging markets' of the day like Japan and Korea were starting to really motor in manufacturing, and the US was less competitive.

I remember the real devastation of the rust belt was the early 80s. First there was the 21 per cent interest rates and what was the worst recession of the postwar years as Paul Volker fought inflation, then the US dollar reached its highest level postwar against other currencies-- nearly 1 to 1 with the British pound, before the Plaza Agreement of September 1985. It absolutely devastated heavy industry in US and Canada. (part of the cause of the 1980-81 recession though was a quadrupling of oil prices $12 to $40, after the Iranian Revolution in March 1979-- that was part of the inflationary spark and the wage-price spiral Volker was fighting).

The US economy is less sensitive to oil prices than it was in the 1970s. Although the economy is much bigger, oil consumption per $1 of GDP is much lower. Transport related industries (cars and trucks in particular) are a much smaller part of the US economy and particularly employment (airlines are more, but they benefit from falling prices). There is no longer the possibility of a wage-price spiral, there are no longer CPI linked union contracts that guarantee that wages go up with inflation.

James Hamilton of University of California San Diego (econbrowser blog) is an expert on oil prices and the US economy. His work shows that recessions tend to follow oil price spikes, because consumer sentiment falls sharply (gasoline is a price everyone knows, everyone pays, and it hits directly at discretionary spending) and because the light vehicle manufacturing sector takes a pounding (car and light truck sales fall more than mere fundamentals would dictate).

Over to an oil price fall. The effect is not symmetric. In the short term places heavily dependent on the energy industry like Texas, Oklahoma, and these days South Dakota etc. take a hit.

The good news is much more diffuse. This has the effect of a tax cut on the American consumer. US consumes c. 21 m barrels/ day so a $40 cut is $840 m b/d into the US economy (but less the x million barrels a day the US produces-- those losses are absorbed by those in the energy industry and energy producing states). c. $250bn pa into the US economy (gross) in a year.

2/3rds of that oil consumption is transport, and about half is private individual driving (so say $450m/ day). All across America individuals and small businesses just got a tax cut, which they receive every time they pay at the pump.

History says they will *spend* that money, but it will take a while to flow through.

BogleRulez
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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by BogleRulez » Wed Dec 10, 2014 7:00 pm

One potential reason: falling oil prices contribute to deflation -- and deflation is bad for the stock market.

Deflation is so dangerous, the Fed's main mission is to protect against it. And the Fed sure has been fighting hard to protect against deflation in recent years. In fact, it's probably accurate to characterize the Fed's activity since end-2008 as an unofficial War on Deflation, though the Fed probably wouldn't use those words (central bankers are hesistant to even say the word "deflation" because they don't want to encourage expectations of deflation).

And falling oil prices contribute to deflation. Not just because oil itself costs less. Lower prices mean less investment in other energy sources, and also less investment in the oil business. To the extent that diminished investment spills over into other markets, you get even more deflation. And deflation was already a big risk before oil prices started tumbling...

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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by richard » Wed Dec 10, 2014 7:02 pm

Valuethinker wrote:
EarlyStart wrote:There is a broader concern that's not about only oil, but is (arguably) indicated by oil.

A lot of people believe that liquidity stimulus (like QE, expanding the money supply, etc) encourages and ultimately creates malinvestment/overproduction/whatever you want to call it. Ultimately the producers realize that they've made too much- the market doesn't demand that much, prices fall, blah, blah, blah.

Which would be a very strange line of argument.

There are 3 areas that have been unusually weak post recession in this economic cycle, compared to virtually every other post war recession:

- government employment (grew much more strongly post 2000 and earlier recessions except 1946 I believe)
- private housing (that may be changing, indeed there *are* signs of bubbles in some markets)
- investment by companies

Companies have been remarkably slow to make investments in new physical capital (plant, equipment and buildings) compared to previous recoveries.

So where, then, is this malinvestment/ overproduction? In 2000, yes, too much into Telecoms-Media-Tech, but this time?

Agreed, the major problem with that argument is that the evidence is at best lacking and at worst to the contrary.

EarlyStart
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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by EarlyStart » Wed Dec 10, 2014 7:06 pm

Valuethinker wrote:
EarlyStart wrote:There is a broader concern that's not about only oil, but is (arguably) indicated by oil.


A lot of people believe that liquidity stimulus (like QE, expanding the money supply, etc) encourages and ultimately creates malinvestment/overproduction/whatever you want to call it. Ultimately the producers realize that they've made too much- the market doesn't demand that much, prices fall, blah, blah, blah.


Which would be a very strange line of argument.

There are 3 areas that have been unusually weak post recession in this economic cycle, compared to virtually every other post war recession:

- government employment (grew much more strongly post 2000 and earlier recessions except 1946 I believe)
- private housing (that may be changing, indeed there *are* signs of bubbles in some markets)
- investment by companies

Companies have been remarkably slow to make investments in new physical capital (plant, equipment and buildings) compared to previous recoveries.

So where, then, is this malinvestment/ overproduction? In 2000, yes, too much into Telecoms-Media-Tech, but this time?



I don't pretend to know the "right" amount of CAPEX for the energy sector, but it has increased as a portion of our total and just in nominal terms. It's not really far-fetched, but that doesn't mean it's correct either. The sector also makes up a large portion of the high-yield debt market, which people are concerned about.

People get hyped up and scared about the wrong things all the time, and people don't notice the elephant in the room too. Some of the concern, founded or not, is related to what's said here.



Image
Last edited by EarlyStart on Wed Dec 10, 2014 7:11 pm, edited 1 time in total.

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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by richard » Wed Dec 10, 2014 7:09 pm

BogleRulez wrote:One potential reason: falling oil prices contribute to deflation -- and deflation is bad for the stock market.

Deflation is so dangerous, the Fed's main mission is to protect against it. And the Fed sure has been fighting hard to protect against deflation in recent years. In fact, it's probably accurate to characterize the Fed's activity since end-2008 as an unofficial War on Deflation, though the Fed probably wouldn't use those words (central bankers are hesistant to even say the word "deflation" because they don't want to encourage expectations of deflation).

And falling oil prices contribute to deflation. Not just because oil itself costs less. Lower prices mean less investment in other energy sources, and also less investment in the oil business. To the extent that diminished investment spills over into other markets, you get even more deflation. And deflation was already a big risk before oil prices started tumbling...

There's not a major economic difference between low inflation and deflation. It's just a difference in degree. Remember that CPI is the average of many prices and at low levels of inflation some prices are falling.

The Fed's main mission is to keep prices stable (which it currently interprets as 2% inflation) and to maximize employment. It has been failing badly at hitting its 2% inflation target - inflation has been below for quite some time and, if you look at TIPS spreads, it will be decades until we hit 2%.

Lower costs should be good for users of energy and spur them to more activity.

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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by toto238 » Wed Dec 10, 2014 7:14 pm

Zecht wrote:
toto238 wrote:...In the end, it's all speculation. The stock market goes down 1% one day, then up 1% the next day. Oil goes up 5% in a day, then down 5% in a day. Why? As a very wise man once said, "Wibbly-wobbly, timey-wimey".


I'm glad I'm not the only person who quotes the Doctor as a legit response to questions.


Rule of the Internet #25147:

If you quote a popular TV show, especially one with a cult following, there will be a fan response. There's always one. Glad to know there are fellow Whovians out there.

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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by richard » Wed Dec 10, 2014 7:18 pm

EarlyStart wrote:<>I don't pretend to know the "right" amount of CAPEX for the energy sector, but it has increased as a portion of our total and just in nominal terms. It's not really far-fetched, but that doesn't mean it's correct either. The sector also makes up a large portion of the high-yield debt market, which people are concerned about. <>

Why would low interests rates cause excessive investment in energy but not other sectors?

It's possible there's too much investment in the energy sector, although as you say, we don't pretend to know the right amount, but a rising share does not necessarily mean too much.

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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by EarlyStart » Wed Dec 10, 2014 7:32 pm

richard wrote:
EarlyStart wrote:<>I don't pretend to know the "right" amount of CAPEX for the energy sector, but it has increased as a portion of our total and just in nominal terms. It's not really far-fetched, but that doesn't mean it's correct either. The sector also makes up a large portion of the high-yield debt market, which people are concerned about. <>

Why would low interests rates cause excessive investment in energy but not other sectors?

It's possible there's too much investment in the energy sector, although as you say, we don't pretend to know the right amount, but a rising share does not necessarily mean too much.


Well, the "frothiness" or "bubble" usually isn't evenly distributed, but I agree that a rising share doesn't necessarily mean too much. Heck, it could be too little or just right.

The argument can be made, though. A sector like energy has it's initial production and capex far removed in time from the consumer, meaning that the time from when the expenditures/investment in a given venture begins is a long period relative to the consumption of the good produced.

e.g. If you and I wanted to start a business and we were deciding between energy exploration and fast food, we know that if we choose energy, the sale resulting from our expenditure is going to take place much much later than the sale of food would.

This means that the amount we produce and spend (if we were in the energy business) would be much more a function of interest rates.

You may have seen the the Hayekian Triangle before. It shows the relationship of interest rates and the price (and thereby incentive to produce and sell) of different stages of production.

Image



Again, the argument can be made, and there are people who are considering this, but I'm not convinced one way or the other. We might look back on this in February and laugh.

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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by scone » Wed Dec 10, 2014 7:39 pm

toto238 wrote:
Zecht wrote:
toto238 wrote:...In the end, it's all speculation. The stock market goes down 1% one day, then up 1% the next day. Oil goes up 5% in a day, then down 5% in a day. Why? As a very wise man once said, "Wibbly-wobbly, timey-wimey".


I'm glad I'm not the only person who quotes the Doctor as a legit response to questions.


Rule of the Internet #25147:

If you quote a popular TV show, especially one with a cult following, there will be a fan response. There's always one. Glad to know there are fellow Whovians out there.



"Oil? An emergency? Ha! It's about time the people who run this planet of yours realised that to be dependent on a mineral slime just doesn't make sense." -- Doctor Who, Terror of the Zygons
"My bond allocation is the amount of money that I cannot afford to lose." -- Taylor Larimore

frugalguy
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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by frugalguy » Wed Dec 10, 2014 8:17 pm

scone wrote:
toto238 wrote:
Zecht wrote:
toto238 wrote:...In the end, it's all speculation. The stock market goes down 1% one day, then up 1% the next day. Oil goes up 5% in a day, then down 5% in a day. Why? As a very wise man once said, "Wibbly-wobbly, timey-wimey".


I'm glad I'm not the only person who quotes the Doctor as a legit response to questions.


Rule of the Internet #25147:

If you quote a popular TV show, especially one with a cult following, there will be a fan response. There's always one. Glad to know there are fellow Whovians out there.



"Oil? An emergency? Ha! It's about time the people who run this planet of yours realised that to be dependent on a mineral slime just doesn't make sense." -- Doctor Who, Terror of the Zygons


I figured the quote was fron Dr. Seuss. :P

Re oil, junk bonds are saying a lot...and they were first to go down before stocks.

Also, any tine there is a "shock" of any kind -- even a seemingly positive one -- it causes`a lot of dislocations in the economy. Gradual price declines don't have the same effect as there is plenty of time to adjust.

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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by tyler_cracker » Wed Dec 10, 2014 10:59 pm

EarlyStart wrote:Image


this is a diagram of how to perform a figure skating maneuver, right?

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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by EarlyStart » Wed Dec 10, 2014 11:17 pm

tyler_cracker wrote:
EarlyStart wrote:Image


this is a diagram of how to perform a figure skating maneuver, right?



Yeah, triple clutz or something like that.

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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by tyler_cracker » Wed Dec 10, 2014 11:58 pm

EarlyStart wrote:Yeah, triple clutz or something like that.


:D

http://www.bogleheads.org/forum/viewtop ... 0#p2201443

whole thread is great but Jupiter's post is the piece de resistance

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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by Valuethinker » Thu Dec 11, 2014 8:09 am

EarlyStart wrote:
richard wrote:
EarlyStart wrote:<>I don't pretend to know the "right" amount of CAPEX for the energy sector, but it has increased as a portion of our total and just in nominal terms. It's not really far-fetched, but that doesn't mean it's correct either. The sector also makes up a large portion of the high-yield debt market, which people are concerned about. <>

Why would low interests rates cause excessive investment in energy but not other sectors?

It's possible there's too much investment in the energy sector, although as you say, we don't pretend to know the right amount, but a rising share does not necessarily mean too much.


Well, the "frothiness" or "bubble" usually isn't evenly distributed, but I agree that a rising share doesn't necessarily mean too much. Heck, it could be too little or just right.

The argument can be made, though. A sector like energy has it's initial production and capex far removed in time from the consumer, meaning that the time from when the expenditures/investment in a given venture begins is a long period relative to the consumption of the good produced.

e.g. If you and I wanted to start a business and we were deciding between energy exploration and fast food, we know that if we choose energy, the sale resulting from our expenditure is going to take place much much later than the sale of food would.

This means that the amount we produce and spend (if we were in the energy business) would be much more a function of interest rates.

You may have seen the the Hayekian Triangle before. It shows the relationship of interest rates and the price (and thereby incentive to produce and sell) of different stages of production.

Image



Again, the argument can be made, and there are people who are considering this, but I'm not convinced one way or the other. We might look back on this in February and laugh.


The problem with Austrian economics is the lack of good mathematical models. Which is why it has no traction with the economics profession generally: academic or practitioner.

Low interest rates did *not* cause overinvestment in energy. High oil prices may have. Investment responds to demand: there are decades of econometric studies showing that, I believe.

What *is* interesting in the Hyman Minsky stuff. That general economic stability leads to bubbles as leveraged investors become an increasing part of the market, eventually rising to Ponzi borrowers (who can only pay back their initial borrowings by borrowing more), and the stage is set for a bubble collapse. See the TMT sectors in 2000, the US housing market 2005-2008 say.

A better way to look at this pattern (than the Austrians) is, in my view, the systems dynamics stuff (Donella Meadows - Thinking in Systems is a good introduction). The basic notion is that we have:

- uncertainty & forecasting error
- long capex lags (years from investment decision to output)

The result, immortalized in first week Business School exercise 'The Beer Game' is a series of overproduction/ prices slashed/ underproduction episodes. This nicely characterizes just about every basic industry/ long capex lag time you can think of: pulp & paper, chemicals, mining, oil and gas and also things like commercial property (UK food retail is going through something similar right now, after years of 'space wars' ie breakneck races to open new space).

The TMT bubble had another manifestation. Positive price momentum in the equity prices (or the wide issuance of debt, see the CDOs) creates the ability to raise more debt and equity. *that* in turn increases apparent demand (Nortel, Lucent etc. selling all that kit). Which drives the price up further.

So contrary to what we learned in economics class, price momentum in the assets creates its own bubbles (and busts) -- higher prices (in the short run) don't necessarily lead to lower demand. You can see this at work in a residential housing bubble.

EarlyStart
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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by EarlyStart » Thu Dec 11, 2014 10:52 am

Valuethinker wrote:
EarlyStart wrote:
richard wrote:
EarlyStart wrote:<>I don't pretend to know the "right" amount of CAPEX for the energy sector, but it has increased as a portion of our total and just in nominal terms. It's not really far-fetched, but that doesn't mean it's correct either. The sector also makes up a large portion of the high-yield debt market, which people are concerned about. <>

Why would low interests rates cause excessive investment in energy but not other sectors?

It's possible there's too much investment in the energy sector, although as you say, we don't pretend to know the right amount, but a rising share does not necessarily mean too much.


Well, the "frothiness" or "bubble" usually isn't evenly distributed, but I agree that a rising share doesn't necessarily mean too much. Heck, it could be too little or just right.

The argument can be made, though. A sector like energy has it's initial production and capex far removed in time from the consumer, meaning that the time from when the expenditures/investment in a given venture begins is a long period relative to the consumption of the good produced.

e.g. If you and I wanted to start a business and we were deciding between energy exploration and fast food, we know that if we choose energy, the sale resulting from our expenditure is going to take place much much later than the sale of food would.

This means that the amount we produce and spend (if we were in the energy business) would be much more a function of interest rates.

You may have seen the the Hayekian Triangle before. It shows the relationship of interest rates and the price (and thereby incentive to produce and sell) of different stages of production.

Image



Again, the argument can be made, and there are people who are considering this, but I'm not convinced one way or the other. We might look back on this in February and laugh.


The problem with Austrian economics is the lack of good mathematical models. Which is why it has no traction with the economics profession generally: academic or practitioner.

Low interest rates did *not* cause overinvestment in energy. High oil prices may have. Investment responds to demand: there are decades of econometric studies showing that, I believe.

What *is* interesting in the Hyman Minsky stuff. That general economic stability leads to bubbles as leveraged investors become an increasing part of the market, eventually rising to Ponzi borrowers (who can only pay back their initial borrowings by borrowing more), and the stage is set for a bubble collapse. See the TMT sectors in 2000, the US housing market 2005-2008 say.

A better way to look at this pattern (than the Austrians) is, in my view, the systems dynamics stuff (Donella Meadows - Thinking in Systems is a good introduction). The basic notion is that we have:

- uncertainty & forecasting error
- long capex lags (years from investment decision to output)

The result, immortalized in first week Business School exercise 'The Beer Game' is a series of overproduction/ prices slashed/ underproduction episodes. This nicely characterizes just about every basic industry/ long capex lag time you can think of: pulp & paper, chemicals, mining, oil and gas and also things like commercial property (UK food retail is going through something similar right now, after years of 'space wars' ie breakneck races to open new space).

The TMT bubble had another manifestation. Positive price momentum in the equity prices (or the wide issuance of debt, see the CDOs) creates the ability to raise more debt and equity. *that* in turn increases apparent demand (Nortel, Lucent etc. selling all that kit). Which drives the price up further.

So contrary to what we learned in economics class, price momentum in the assets creates its own bubbles (and busts) -- higher prices (in the short run) don't necessarily lead to lower demand. You can see this at work in a residential housing bubble.



I have no allegiance to this opinion about what's going on in oil prices. My point was that this is an area of concern for some market participants, and it may explain some of the recent fluctuations.

You can make econometric models say whatever you want. I've done probably hundreds of them. That's not to say that they're worthless, but we could find econometric models that contradict one another (not directly- variable for variable), and we ultimately go back to debating the theory behind them.


I'll state again that I really don't know what's going on with oil, but hear me out.

"natural" interest rate= 4%

Oil Company X believes it can earn a 2% profit (after adjusting for time value) from the exploration of a new site, marginal production, etc. If it has to borrow at 4%, they'd incur an expected loss of 2%/year, ceteris paribus.

Same company, but we've managed to to stimulate and expand the money supply. Oil company X can borrow at 1% now. They see potential profit and go ahead with production expecting 1% profit per year (after adjusting for time value). Some time after they've began, interest rates have creeped back up to 4%, and now they stand to lose 2% per year.

Also: "So contrary to what we learned in economics class, price momentum in the assets creates its own bubbles (and busts) -- higher prices (in the short run) don't necessarily lead to lower demand. You can see this at work in a residential housing bubble."

Well yeah, but those people are essentially "producers" who have higher demand to own and ultimately sell more expensive goods. It's not really contrary to conventional theory. It's just that the sellers are selling to other sellers. Say that 5x fast.


It's somewhat similar to what you mentioned:

- uncertainty & forecasting error
(part of the forecasting error involved estimation of market time preferences, which are indicated by real interest rates, and the marginal cost of production)
- long capex lags (years from investment decision to output)
(long capex lags are what make the production decisions sensitive to interest rates)


To be completely forthright, I don't think there's only one game in town when it comes to bubbles. Animal spirits, monetary accommodation, full moons on trading days, a herd mentality, plain stupidity, faulty forecasting, etc. etc. probably all play some role.


I don't disagree with most of what you're saying, but I think it's clear that SOME people are concerned about "froth" in the markets. Whether it's there or not, we'll have to wait and see.

I trust you'll be staying the course like I (hopefully) will be? I'm grateful that my return doesn't depend on my being right about this. Thank goodness, because that'd be a losing proposition.

Valuethinker
Posts: 33144
Joined: Fri May 11, 2007 11:07 am

Re: Why are Falling Oil Prices Bad for the Stock Market

Post by Valuethinker » Thu Dec 11, 2014 11:24 am

EarlyStart wrote:

I have no allegiance to this opinion about what's going on in oil prices. My point was that this is an area of concern for some market participants, and it may explain some of the recent fluctuations.

You can make econometric models say whatever you want. I've done probably hundreds of them. That's not to say that they're worthless, but we could find econometric models that contradict one another (not directly- variable for variable), and we ultimately go back to debating the theory behind them.


I'll state again that I really don't know what's going on with oil, but hear me out.

"natural" interest rate= 4%

Oil Company X believes it can earn a 2% profit (after adjusting for time value) from the exploration of a new site, marginal production, etc. If it has to borrow at 4%, they'd incur an expected loss of 2%/year, ceteris paribus.

Same company, but we've managed to to stimulate and expand the money supply. Oil company X can borrow at 1% now. They see potential profit and go ahead with production expecting 1% profit per year (after adjusting for time value). Some time after they've began, interest rates have creeped back up to 4%, and now they stand to lose 2% per year.

Also: "So contrary to what we learned in economics class, price momentum in the assets creates its own bubbles (and busts) -- higher prices (in the short run) don't necessarily lead to lower demand. You can see this at work in a residential housing bubble."

Well yeah, but those people are essentially "producers" who have higher demand to own and ultimately sell more expensive goods. It's not really contrary to conventional theory. It's just that the sellers are selling to other sellers. Say that 5x fast.


It's somewhat similar to what you mentioned:

- uncertainty & forecasting error
(part of the forecasting error involved estimation of market time preferences, which are indicated by real interest rates, and the marginal cost of production)
- long capex lags (years from investment decision to output)
(long capex lags are what make the production decisions sensitive to interest rates)


To be completely forthright, I don't think there's only one game in town when it comes to bubbles. Animal spirits, monetary accommodation, full moons on trading days, a herd mentality, plain stupidity, faulty forecasting, etc. etc. probably all play some role.


I don't disagree with most of what you're saying, but I think it's clear that SOME people are concerned about "froth" in the markets. Whether it's there or not, we'll have to wait and see.

I trust you'll be staying the course like I (hopefully) will be? I'm grateful that my return doesn't depend on my being right about this. Thank goodness, because that'd be a losing proposition.


Thank you for the elucidation.

I basically don't believe Austrian models. There's no 'natural' rate of interest. On that, I think, we fundamentally differ.

I think an Austrian model would struggle to explain why *this* sector? Why not other sectors? Demand is about pull as well as push. Yes capital was seeking higher returns and was cheap by historic measures (depending on what you think the market was expecting about inflation) but why oil? And the answer, I think, has to be that oil prices were high-- at $100/bl almost any investment in new oil production made sense. Even something like Natural Gas Liquids.

Minsky's addition was that stable low interest rates make it easier for speculators to build up leveraged positions, eventually magnifying the crash when it comes.

As has been pointed out, macro theory was somewhat blind to all this, but international economics was not, because such cycles happen all the time: currency bubbles and busts, and exchange rate and debt crises in emerging markets etc.

crg11
Posts: 390
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Re: Why are Falling Oil Prices Bad for the Stock Market

Post by crg11 » Thu Dec 11, 2014 11:31 am

Interesting set of slides in this article, especially the one that shows oil consumption in the US vs. GDP.
http://www.bloomberg.com/graphics/2014- ... addiction/

richard
Posts: 7961
Joined: Tue Feb 20, 2007 3:38 pm
Contact:

Re: Why are Falling Oil Prices Bad for the Stock Market

Post by richard » Thu Dec 11, 2014 11:36 am

Valuethinker wrote:<>Investment responds to demand: there are decades of econometric studies showing that, I believe.<>

No, no. Investment responds to the confidence fairy. Just ask your PM and Chancellor.

:P

EarlyStart
Posts: 258
Joined: Thu Nov 20, 2014 9:36 pm

Re: Why are Falling Oil Prices Bad for the Stock Market

Post by EarlyStart » Thu Dec 11, 2014 11:37 am

Valuethinker wrote:
EarlyStart wrote:

I have no allegiance to this opinion about what's going on in oil prices. My point was that this is an area of concern for some market participants, and it may explain some of the recent fluctuations.

You can make econometric models say whatever you want. I've done probably hundreds of them. That's not to say that they're worthless, but we could find econometric models that contradict one another (not directly- variable for variable), and we ultimately go back to debating the theory behind them.


I'll state again that I really don't know what's going on with oil, but hear me out.

"natural" interest rate= 4%

Oil Company X believes it can earn a 2% profit (after adjusting for time value) from the exploration of a new site, marginal production, etc. If it has to borrow at 4%, they'd incur an expected loss of 2%/year, ceteris paribus.

Same company, but we've managed to to stimulate and expand the money supply. Oil company X can borrow at 1% now. They see potential profit and go ahead with production expecting 1% profit per year (after adjusting for time value). Some time after they've began, interest rates have creeped back up to 4%, and now they stand to lose 2% per year.

Also: "So contrary to what we learned in economics class, price momentum in the assets creates its own bubbles (and busts) -- higher prices (in the short run) don't necessarily lead to lower demand. You can see this at work in a residential housing bubble."

Well yeah, but those people are essentially "producers" who have higher demand to own and ultimately sell more expensive goods. It's not really contrary to conventional theory. It's just that the sellers are selling to other sellers. Say that 5x fast.


It's somewhat similar to what you mentioned:

- uncertainty & forecasting error
(part of the forecasting error involved estimation of market time preferences, which are indicated by real interest rates, and the marginal cost of production)
- long capex lags (years from investment decision to output)
(long capex lags are what make the production decisions sensitive to interest rates)


To be completely forthright, I don't think there's only one game in town when it comes to bubbles. Animal spirits, monetary accommodation, full moons on trading days, a herd mentality, plain stupidity, faulty forecasting, etc. etc. probably all play some role.


I don't disagree with most of what you're saying, but I think it's clear that SOME people are concerned about "froth" in the markets. Whether it's there or not, we'll have to wait and see.

I trust you'll be staying the course like I (hopefully) will be? I'm grateful that my return doesn't depend on my being right about this. Thank goodness, because that'd be a losing proposition.


Thank you for the elucidation.

I basically don't believe Austrian models. There's no 'natural' rate of interest. On that, I think, we fundamentally differ.

I think an Austrian model would struggle to explain why *this* sector? Why not other sectors? Demand is about pull as well as push. Yes capital was seeking higher returns and was cheap by historic measures (depending on what you think the market was expecting about inflation) but why oil? And the answer, I think, has to be that oil prices were high-- at $100/bl almost any investment in new oil production made sense. Even something like Natural Gas Liquids.

Minsky's addition was that stable low interest rates make it easier for speculators to build up leveraged positions, eventually magnifying the crash when it comes.

As has been pointed out, macro theory was somewhat blind to all this, but international economics was not, because such cycles happen all the time: currency bubbles and busts, and exchange rate and debt crises in emerging markets etc.


I agree that there wouldn't be a clear answer to "why this sector", although I don't have a great answer either.

I do think we're not nearly as leveraged as we were several years ago, which should mean that a correction won't be as catastrophic as the last, all else equal. As you correctly point out, that can be the real kicker. I'm young, so I'll just keep contributing no matter what. Heck, I'd like to buy at lower prices.

EarlyStart
Posts: 258
Joined: Thu Nov 20, 2014 9:36 pm

Re: Why are Falling Oil Prices Bad for the Stock Market

Post by EarlyStart » Thu Dec 11, 2014 11:43 am

richard wrote:
Valuethinker wrote:<>Investment responds to demand: there are decades of econometric studies showing that, I believe.<>

No, no. Investment responds to the confidence fairy. Just ask your PM and Chancellor.

:P


“Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits—a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.”
-JMK

No, no no. You've got it all wrong. Animal spirits. Your parents haven't told you the confidence fairy isn't real?

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