The relationship between the global prices of oil and gas and the performance of stock markets has long been examined and analyzed both by academic researchers, professionals in the field of finance and investing, and economic managers.
Some of these studies have suggested that sharp increases in oil and gas prices negatively impact the valuation of companies listed in stock markets. But others have noted that the relationship between the two is correlational rather than causal.
How exactly do oil and gas prices affect the stock market? What is the exact relationship between the two? How do stock traders and investors perceive and subsequently react to increases or decreases in the global prices of oil and gas?
Explaining How Oil and Gas Prices Affect the Stock Market
Studies and Reports
A 2021 study by F. Alamgir and S. Bin Amin published in Energy Reports used a Nonlinear Autoregressive Distributed Lag to analyze the interactive link between oil prices and the stock market in four selected South Asian countries from 1997 and 2018.
Results showed that there was a relationship between the global oil prices and the stock market index. The stock market index also has an asymmetric response to positive and negative oil price shocks. In addition, the study noted that higher oil prices stimulate stock price, thus suggesting that the stock markets in South Asia do not follow the Efficient Market Hypothesis.
A 2004 bulletin published by the European Central Bank or ECB also examined the relationship between trends in oil and gas prices and the performance of the Dow Jones EURO STOXX index from January 1987 to July 2004.
Historical data showed that the stock index in the European Union increased on average by 1 percent per month during periods of low-level to medium-level of oil prices, and was negatively affected during periods of high oil prices. The ECB concluded that these trends remain consistent with the view that oil prices affect stock prices because of corporate earnings outlook.
But researchers at the Federal Reserve Bank of Cleveland arrived at a conclusion that there is little correlation between oil and gas prices and stock market performance over time after analyzing price movements in both markets.
Of course, their conclusion should not be construed as a complete claim that the prices of oil and gas have a very limited impact or influence on the prices and performance of the stock market. However, the findings of these researchers suggest that analysts and investors cannot predict how the stock market reacts to changes in oil and gas prices.
Factors and Considerations
Tommy Stubbington and Georgi Kantchev for The Wall Street Journal that the price trends based on Brent crude oil benchmark and the performance of S&P 500 moved in close alignment in 2016. They explained that this reflects a fear of a global recession.
An analysis by economist Ben S. Bernanke also explained that the tendency of the stock market to move with oil and gas prices can be explained by their tendency to react in the same direction to common factors: aggregate demand, overall uncertainty, and risk aversion. He added that the residual correlation is close to zero even when these factors are accounted for.
It is interesting to note that the stock prices of businesses in several industries and sectors tend to perform positively during periods of increasing oil and gas prices. Examples include businesses involved in oil and gas production and distribution.
However, for industries and sectors in which hydrocarbons are the main input, such as those in the transportation and manufacturing businesses, higher fossil fuel prices result in poor stock performance. Investors are averse to these companies due to concerns about increased operational costs and negative impacts on corporate earnings.
Sharp increases in the prices of oil and gas in the global market can also serve as a benchmark for economic growth trajectory. This has been evident when Russia invaded Ukraine in February 2022 and the prices of hydrocarbons increased following economic sanctions.
The United States banned Russian oil and gas imports while the United Kingdom and E.U. announced that they would decrease dependency on Russian hydrocarbons. The sharp increase in oil and gas prices signaled traders and investors to let go of several stocks out of fear that it would affect ongoing economic recovery from the COVID-19 pandemic.
Understanding How Oil and Gas Prices Influence the Stock Market
Note that the literature about the relationship between oil and gas prices and the performance of stock markets suggests mixed results. Some analyses showed a positive correlation between the two. Others noted little to zero relationship.
The dynamics between these two markets are fundamentally complex. There are different factors at play that should be considered when analyzing and understanding why on several occasions, increases in the prices of oil and gas prices often result in a decrease in the overall performance of the stock market of a particular country.
Remember that hydrocarbons remain one of the most traded and consumed commodities in the world. These are production inputs that fuel a number of economic activities. Access to these resources can also determine the economic growth of a country.
Sharp increases in their prices paint a negative outlook from the perspective of traders and investors. Their tendency is to forego stocks and switch to other securities and financial derivatives. However, in some cases, especially in countries with strong oil and gas industries, these price increases can signal a positive economic growth trajectory.
One of the factors affecting the prices of oil and gas is the prevailing economic condition. The 2007-2008 Financial Crisis and COVID-19 pandemic saw sharp price increase due to low demand for oil and gas following economic slowdowns and depressed business activities.
FURTHER READINGS AND REFERENCES
- Alamgir, F. and Bin Amin, S. 2021. “The Nexus Between Oil Price and Stock Market: Evidence from South Asia.” Energy Reports. 7: 693-703. DOI: 1016/j.egyr.2021.01.027
- Bernake, B. S. 2016. “The Relationship Between Stocks and Oil Prices.” Brookings. The Brookings Institution. Available online
- European Central Bank. 2004. “How Do Stock Markets React to Changes in Oil Prices?” ECB Monthly Bulletin. European Central Bank. Available via PDF
- Pescatori, A. and Mowry, B. 2008. Do Oil Prices Directly Affect the Stock Market? Federal Reserve Bank of Cleveland. Available online
- Stubbington, T. and Kantchev, G. 2016. “Oil, Stocks at Tightest Correlation in 26 Years.” The Wall Street Journal. Available online
