Not long ago, I posted about how oil prices would never see anything near $100 a barrel again, because as soon as prices started climbing above $50 or $60, U.S. producers would crank up previously idled oil fields, and that is just what happened.
With OPEC’s oil production cut earlier this year, prices indeed did start rising, and U.S. producers turned the pumps back on. Prices have made it back up in to the fifties. Today, however, prices slipped back below $50 per barrel ahead of a report on U.S. oil rig count that most analysts predict will show even more U.S. production coming online. Couple that with uncertainty about whether OPEC — and Russia — will extend their supply cuts, and you have investors nervous that prices have nowhere to go but down.
Oil Prices and U.S. Stock Prices
The reality is that, for America, $50 per barrel is a pretty happy medium spot. At $50 per barrel, oil value is high enough for most U.S. producers to make a profit, and for banks to continue feeling good about credit backed by oil reserves. Together, this keeps the stocks of S&P 500 companies like Exxon and Shell and so on from dropping down and dragging the Dow Jones and S&P 500 index with them.
At the same time, $50 a barrel oil translates into a comfortable, low $2’s range for gas prices. In other words, $50 per barrel doesn’t hurt U.S. stocks, or the U.S. stock market, while also not hurting U.S. consumers, and companies that depend on fuel like transportation, shipping, and others.
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Investing and Oil Prices
For stocks that aren’t directly tied to oil, the concern is not so much that lower oil prices down in the $40 per barrel range would directly affect stocks like Apple, GE, IBM, and the like. Rather, the concern is that the hit actual oil producers and providers would take might be just the outside shock that causes the markets to finally react to what many analysts see as a growing overvaluation.
As we discussed previously, the stock market often corrects itself without a violent crash, but rather with an extended sideways run, or even a gentle, months long correction. It usually takes an outside event to shock the markets into a full collapse, and oil company’s (and related) stocks falling due to oil prices that are too low, might be just that shock.
What should investors do?
As always, for long-term investors, the answer is to maintain a well-diversified portfolio customized for your goals and risk tolerance. The ups and downs, and even potentially unpleasant shocks of an oil price inspired crash will all work themselves out over time with regular rebalancing and regular investments.
For short-term investors, it’s too soon to pull the trigger on any oil price-based strategies. A short blip under $50 does not an oil slump make. It’s still possible that U.S. oil rig count is nearing its top for this price point and that things will stabilize right around the $50 mark. In short, keep a close eye on oil prices but wait for $45 or even $44 before thinking about what happens next.
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For medium-term investors, it’s time to start thinking about what you want to own through the rest of this year and next year. No matter how much oil exposure you have right now, you don’t need anymore. If you are over-exposed to oil (what were you thinking?) now is the time to trim back.
That being said, this is not the time for panicked selling either. Trim your positions if they are too concentrated, but otherwise, it is probably sufficient to direct your investments elsewhere for the foreseeable future as a way to reduce overall exposure. Keep in mind that includes being cautious not just on oil related companies, but oil dependent countries as well.
For now, $50 is just fine. It’s the next $5 up or down that should set the wheels in motion.