Articles
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Why the oil collapse is good for the global economy…
The rapid collapse in oil prices to 12-year lows has taken investors by surprise and convinced many that we are headed for a recession.
After all, the stock market is a leading indicator for the economy – and the signal it is sending is hardly the best.
Many investors are misreading the drop in oil, however. There is a strong case to be made that a recession is not looming in the U.S. and the worst of this equity selloff may already be behind us.
Here’s why…
Economist Paul Samuelson famously said that the stock market had predicted “nine of the last five recessions.” Translation: Not every market correction – or bear market – is a prelude to an economic downturn. Sometimes we get a false signal.
This may well be one of those times.
For example, pessimists point to the slowdown in China, the world’s second-largest economy, as a particularly inauspicious development. Yet U.S. businesses export roughly $500 billion a year to that country. Even if exports plunge 20%, that’s a relative pittance to our $18 trillion economy.
Another alarm bell is the so-called “earnings recession.” An economic recession is two consecutive quarters of negative GDP growth. An earnings recession is two consecutive quarters of negative profit growth. That’s exactly what we’ve had the past two quarters. And we may soon get a third…
However, the primary cause has been the collapse in oil, gas, copper and other commodities. The earnings recession is confined almost entirely to energy and basic materials. Energy earnings, in particular, are off more than two-thirds from a year ago. That’s because oil is at a 12-year low and natural gas is near a 20-year low.
Some analysts believe the fall-off demonstrates growing economic weakness around the globe. That’s partially true… but hardly the whole story.
Oil is also cheap because new technologies – horizontal drilling and hydraulic fracturing – have made it more economical to recover shale deposits. (A little over a year ago, we surpassed Russia to become the world’s largest oil and gas producer.) The inability of OPEC to control production – thanks to Saudi Arabia keeping the spigots wide open to protect market share – has also boosted supply. And the removal of economic sanctions against Iran means its oil is now hitting the market too, adding to the glut.
Lower oil prices are bad for exploration and production companies. It also means capital spending will fall along with jobs in the sector.
However, low oil and gas prices are an enormous positive for the vast majority of households, businesses and governments. We will all pay less to drive, fly, and heat and cool our homes and offices.
The misreading comes from people who insist that the sell-off in oil is due to weak demand. But demand is not weak. As you’d expect, when the price of something vital plunges – like oil and gas – demand goes up not down.
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