In spite of a recent rebound, oil prices remain at very low levels. For many, initial joy at falling gasoline prices has given way to a darker realization. The oil glut has depressed Houston’s economy, which is heavily dependent on the petroleum industry. And if you work in the industry, your situation may appear even bleaker.
In this environment, how worried should you be about your investment portfolio? Are low oil prices draining all the energy out of the markets? A recent white paperfrom Dimensional Fund Advisors made some very clear-eyed points that I’d like to share with you.
1. The current oil market is supply-driven
If you recall economics 101, prices fall when there is a decrease in demand, an increase in supply or some combination of the two. The data indicate pretty clearly that the current decline in oil prices is supply-driven. While demand for oil has stayed relatively stable throughout, supply has spiked upward, largely due to new U.S. sources of production. This is good news. A price decline driven by weak demand for oil might indicate a sputtering global economy. An excess of supply, on the other hand, doesn’t necessarily indicate anything negative about the overall economy.
2. In the long run there’s little correlation between oil and equities
Over the past ten years, the statistical correlation of crude oil with U.S. stocks is 0.33. With non-U.S. stocks it is 0.37. For comparison, a correlation of 1 indicates two variables that move in perfect synch with each other (when one goes up, the other goes up, and vice versa). A correlation of -1 indicates two variables that move opposite of each other (when one goes up, the other goes down, and vice versa). A correlation of 0 indicates two variables whose movements show no relation to each other (when one goes up, the other might just as easily go up, go down or stay the same). So figures like 0.33 and 0.37, while showing some positive correlation between oil and equities, are closer to no correlation (0) than to perfect correlation (1).
Furthermore, when looking at data from a longer period, 1986-2015, there is even less correlation of oil prices with both U.S. stocks (0.02) and non-U.S. stocks (0.05). Based on these figures, a depressed oil market, by itself, tells you little to nothing about the stock market.
3. Oil stocks make up a fairly small proportion of the stock market
But what about the stocks of oil companies themselves, you may ask. To be sure, low oil prices are not generally good for those particular assets. But in a portfolio that’s properly diversified across the market, such stocks will not play a dominant role. For instance, energy-sector stocks make up only 6.5% of the S&P 500 index, and 5.9% of the Russell 3000.
Of course, not everyone’s investments are as diversified as they should be. If this applies to you, come see PARTNERSINWEALTH. We put you in control of your finances by removing clutter and replacing guesswork with planning. The result: the growth of your net worth accelerates while you rest easy. To learn more, please contact Jim Waters, CFP®, at 713.964.4028 or firstname.lastname@example.org.