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Is It Time to Fear Oil? Not Until These Three Conditions Are Met

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Fortunately, not one of the three is happening right now.

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MINYANVILLE ORIGINAL

I never worry about action, but only inaction.
--Winston Churchill

Yesterday I participated in an interactive webcast hosted by Minyanville exclusively for Buzz & Banter subscribers, and a lot of really great topics were brought up. One participant wanted me to address the impact of oil on markets given fears over an impending military conflict in the Middle East and the potential spike in energy prices that could cause.

As to oil more generally, gradually rising oil is correlated with rising stocks. Why? Because gradually rising oil increases cost-push inflation, which in turn causes inflation expectations to rise. This is a favorable environment for risk assets as I have generally discussed for some time in my writings. When oil spikes, however, expectations for deflation kick in because the speed of the move makes it impossible for companies to react quickly enough.

As to when to fear oil, I noted that three conditions must be met before prices would be affected (the "Oil Spike Trifecta").

First, oil itself (USO) would have to begin to substantially outperform stocks (IVV). Second, energy stocks themselves (XLE) would have to underperform broader stock market averages, because a spike in oil prices would be damaging to longer-term planning. Third, the stocks of military contract providers would have to begin to dramatically rally as money bets on impending conflict.

Not happening as of right now. Take a look below at the price ratio of the PowerShares Aerospace & Defense (PPA) portfolio relative to the S&P 500 (IVV). As a reminder, a rising price ratio means the numerator/PPA is outperforming (up more/down less) the denominator/IVV. A falling ratio means the opposite.


Notice that despite war talk, the performance of defensive stocks on average has been anything but strong. The ratio continues to point lower, as money, in reality, bets that conflict will be avoided. That, combined with oil itself not performing that well, suggests we don't have to be too concerned in the near-term for now based on the way money is betting.

'Nuff said.

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.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

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