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Drillers: Higher Oil Still Possible (and It's OK)


While painful for the consumer, rising oil prices that are steady could be good for risk-assets. Oil services and equipment stocks seem to believe that's what could happen.

I did a segment on CNBC yesterday which seems to be getting some buzz today on the idea I presented, which is that rising oil prices could be bullish for equities as much as they are negative for consumers. In summary, if oil prices rise in a gradual and steady way, it likely would result in a pickup in inflation expectations. Followers of my writings are aware that I focus specifically on the direction of inflation expectations because that largely drives the asset allocations decision (bonds or stocks). The cause and effect works in a way such that gradually rising oil prices causes inflation expectations to increase, which in turn would likely force money out of bonds and back into risk-assets.

The speed of the move is the key. If investors do expect higher oil prices to be gradual, that likely means money flows into those areas of the stock market sensitive to increased drilling and oil-finding/extraction activities. Take a look below at the price ratio of the iShares Dow Jones US Oil Equipment & Services ETF (IEZ) relative to the S&P 500 (IVV). As a reminder, a rising price ratio means the numerator/IEZ is outperforming (up more/down less) the denominator/IVV.

I've annotated the chart to show that the move higher in IEZ coincides with the reflationary environment the world found itself in suddenly following the Summer Crash of 2011 (ignoring the Italy "hiccup" in early November). The trend still looks to potentially be early, which means investors seem to be betting on an increased pickup in oil-finding activities. Once again, for the stock market, this may be OK. Remember that there is actually a strong positive correlation between stocks and gradually trending oil prices.

Twitter: @pensionpartners
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No positions in stocks mentioned.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

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