CRUDE OIL AND FINANCIAL MARKETS

When many people ask about the relation between oil prices and the stock market, they are specifically asking whether falling oil prices are able to predict declines in the stock market.  To examine this issue, it is necessary to look at the relation between previous oil price changes and subsequent market returns.  Looking at the period 1986-2015, we calculated average monthly stock returns conditional on previous spot oil returns.  The average returns show no evidence that falling oil prices predict declining  stock markets

.IS THE FALLING OIL PRICE DUE TO A SLACKENING IN DEMAND, WHICH COULD SIGNAL AN ECONOMIC SLOWDOWN?

The US crude oil stock (inventory) has risen in recent months, from less than 360 million barrels in late September 2014 to more than 490 million barrels as of January 22,2016.  During that time, the spot oil price has declined more than 60%.  The evidence shows that this increase in the crude oil stock has not been due to slackening demand.  Ignoring seasonal fluctuations, the amount of crude oil supplied to refineries has been steadily increasing since 2010.  Instead, the noticeable increase in production, only partially offset by a decrease in imports, has been the catalyst for increased crude oil inventories.

Global supply and demand determines oil prices, and it is possible that these US statistics would not capture a reduction in the global demand for crude oil. For evidence of this possibility, data supplied by the US Energy Department has shown since 1970 that Total World Liquid Fuels Consumption was 75 million of barrels per day and by 2015 has steadily increased to over 90 million of barrels per day.

The numbers do not allow us to make predictions about future crude oil demand.  They simply provide evidence about recent demand, and the evidence suggests that demand has not fallen off.

HOW MUCH WEIGHT DO ENERGY FIRMS REPRESENT VARIOUS EQUITY AN FIXED INCOME INDICES ?

As of December 31,2015, the energy sector(including refineries and natural gas producers) had the following index weights: