Will Oil Carry the Market?

Oil has been the hottest topic fueling the market recently, and while jet fuel may not melt steel beams, it has certainly become a commodity that has rocked the foundations of the financial market.

Within the past 5 years, Brent Oil has seen a maximum drawdown of 77.67% in its price per barrel, causing massive employment cuts and crumbling the financial stability of oil and gas firms around the world. Finite as this resource may be, oil's prices seem to have been hit largely because of an ironic massive oversupply created by the world's biggest oil producers (think OPEC). 

Adding fuel to the fire, the slowdown of some of the largest economies in the world, i.e. BRIC economies, has led to a fall in global demand for oil. Brazil and Russia, for example, have just experienced their fourth straight quarter of contraction, with their latest growth rates at -1.4% and -3.8% respectively.

The question now is, why have oil prices shot up over the past few months, and is it a leading indicator of market recovery? Using Brent Oil as a proxy, we can see that over the past 3 months, USD per barrel has risen by a maximum of 64.85%. This could partly be due to the slow but steady failure of oil companies around the world (particularly shale oil producers in the US) as they produce at costs above market prices. To make matters worse, the recent FED rate hike of 0.25% means that financial institutions have become more reluctant to splash cash on these troubled oil producers.

More importantly, however, is that this jump in oil prices has caused a surge in global markets. The iShares MSCI World posted a 3.14% rise in the past month, while the local market jumped 9.65% in the same period. But does this mean that markets have finally gotten out of the rut? 

Some of us might want to jump onto the bandwagon with hopes that the markets are finally on the road to recovery, and by all means, do so. I have benefited from the wave myself, and statistics have always shown markets to recover. But investing with caution is probably the main theme at this point, largely because there are two main issues which have not yet been addressed even as markets rise:

1. The underlying fundamentals pertaining to the growth of economies have not changed significantly. In fact, some are still showing sub-par performances, while others maintain moderate outlooks. US unemployment still holds at 4.9%, unchanged from the previous quarter, while China faces its lowest GDP growth rate in 25 years.

2. Conventional wisdom does not link rising oil prices to growth. Quite the converse actually. Just about every industry uses oil in its process, and rising oil prices coupled with rising interest rates only serve to suffocate industries in their already weakened states. Bloomberg even wrote an article on how the high oil prices potentially affect economic growth back in 2012 (click here for it). These increased costs continue to trickle down to the average consumer, causing them to spend less, and ultimately results in a reduction in GDP growth. 

With this said, certain companies are displaying prices that seem well-worth the money. DBS, for example, was priced at almost 0.8x its book value just a week ago. Whether that's a great bargain or the market's realization of DBS' true risk is entirely up to us. Investing is ultimately more of an art than a science; and while current price surges might be unsupported fundamentally, it makes little sense to go against the market either.

While waiting for the wave of a lifetime, a good surfer rides the smaller waves, exiting before each one crashes, gaining invaluable experience and enjoyment as he goes.