The price of a barrel of oil plummeted from $76 in October 2018 to under $50 a month later. And the reasons for the price drop are the topic of conversations everywhere.
Is it because the Farmer’s Almanac is calling for mild winter months? Is a global economic slowdown in store for 2019? Or are we producing more? Or less?
Look at the rapid decline in the price of oil, which seemed to sneak up on us. But did it really?
Examining the long-term trend in oil prices, it’s very clear that the price of crude oil has been in a downward trend since early 2008.
The peak price was in June 2008 when it reached a bit more than $160/barrel – only to crater to about $56/barrel 18 months later. You remember 2008, right?
Sure, the price of oil clawed back into the $110 - $120 range at times, but over the past 20 years, pull-backs always seemed to happen.
In fact, since the summer of 2004, the price of oil has been below $100/barrel consistently, bottoming out at $36/barrel in January 2016 and trending upward since that point – although never breaching the $80/barrel threshold.
While this was good for consumers and transportation companies, plummeting prices forced the energy sector into an unusual departure for an otherwise robust stock market. One only needs to look at the performance of the Energy sector over the past decade to confirm this fact:
Of the 11 sectors in the S&P 500, the Energy sector was the worst performer over the past 10-years
Through November 30, 2018, the Energy sector lost about 24% for the 5-year period (the 3-year number is just in positive territory)
Through November 30, 2018, the Energy sector lost close to 10% for the 1-year period
Randomness in Markets?
The trapdoor opening on oil prices provides a good example of how randomness is inherent in all investment markets. As much as we would like to think that all investments progress in logical patterns and for justifiable reasons, that’s simply not true all the time. And there are no signals when trends will change or how sharply.
As scholar Nassim Taleb writes in his book Antifragile: Things That Gain from Disorder, sometimes complacency and the appearance of steadiness form the impetus for swift market change. “Absence of fluctuations in the market causes hidden risks to accumulate with impunity.” Taleb writes. “The longer one goes without a market trauma, the worse the damage when the commotion occurs. Our minds are in the business of turning history into something smooth and linear, which makes us underestimate randomness. But when we see it, we fear it and overreact.”
Is an overreaction driving the oil price below $50 per barrel in 2018?
Remember this: It’s hard to say what the right price is for a commodity like oil and thus when the price is too high or too low.
Regardless, when a trend is changing, don’t expect to see a signal. Any forecasts you see about oil prices will almost surely be inaccurate. A fact of market life is to expect randomness. Little-understood or appreciated market influences propel changes in direction.
Oil Prices & Market Sentiments
Now that oil has everyone’s attention, it likely won’t be what causes the next sharp change in up or down market sentiment. But that doesn’t mean the price of oil won’t continue to be on investors’ radar.
This is not to insinuate that you should prepare for a market correction in 2019. Certainly, the U.S. economy continues to post impressive growth relative to the rest of the developed world. And there are many factors showing positive trends. Plus, by most measures, the U.S. stock market is not expensive.
We simply cannot predict which of these influences – or something else – will lead to a major market trend.
Article written by Natalie Banta, Associate Professor in Law, Drake University
RSW Publishing has an agreement to republish this author’s content.
This article was originally published on The Conversation.
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