I have sympathy for journalists who must come up with plausible stories for market fluctuations even when none is obvious. So as the market continues to fluctuate, we seem to get a new story every week. Could it be that these stories are as much drivers of the current market as explanations of it?
At first it was all about China and the decline of its stock market. Long-standing concerns about over-investment, shadow banking and the accuracy of official statistics suddenly loomed large in some commentaries. The narrative tended to encourage exaggeration of the importance of the Chinese economy for global growth, never mind that US exports to China accounts for 0.6% of GDP, and not much more for other developed economies.
Then we heard that it was all the Federal Reserve’s fault for raising rates, never mind that the modest rise was clearly signaled so far in advance that only a Rip Van Winkle could have been surprised. Now we hear the market is a harbinger of a coming recession. I am reminded of a quip by another Nobel economist, Paul Samuelson: “The stock market has forecasted 9 of the last 5 recessions.” He said that 50 years ago. It’s just as true today.
But for an economist like myself, the stock market’s obsession with oil prices is the most puzzling. Since December, there’s been a nearly 90% correlation between oil prices and stock prices. When oil has dropped, stocks have followed. This is historically rare and hard to rationalize because there are only a few corners of the stock market where cheap oil is actually bad news – oil producers, obviously, and banks that have lent money to shale-oil drillers. Cheap oil is a boon for most companies. Take air transportation: jet fuel is the single largest variable cost in that industry and the drop in oil prices has resulted in a sharp increase in their profits. Yet the Air Transport sector of the all-cap US Russell 3000® Index has fallen in lockstep with the price of oil to the tune of -12.9% year-to-date as at 3 February 2016.
There are several stories circulating to explain this. One story is that the fall in oil prices tells us that global demand - especially demand from China – is weak. But in fact, global oil consumption has been growing at a steady pace, with no sign of a slowdown. What has changed is a huge increase in supply from US oil-shale production and the reopening of supply from Iraq and Iran.
Another story is that cheap oil directly hurts the US economy. The oil patches of North Dakota and Oklahoma have indeed been hit hard. But the US is still a net importer of oil and the drop in oil prices amounts to a windfall for consumers. One study estimates that Americans have an extra 10 billion dollars to spend every month. So reading a lot into oil prices is problematic at best. Boom and bust cycles within the industry are common, and they often have nothing to do with the larger economy.
Sources: FTSE Russell and the Federal Reserve Bank of St. Louis. Data as at 3 February 2016. Past performance is no guarantee of future performance. Please see the end for important legal disclosures.
But once a narrative becomes popular it can take on a life of its own. Many might think that if everyone else is going to sell when oil prices fall then they’d better too, regardless of whether they believe the narrative. The herd instinct takes over and the narrative can become self-fulfilling.
So given the dearth of truly bad news, will the market bottom out soon? Time will tell, but I’m reminded of a quip from another famous economist, John Maynard Keynes: “The market can stay irrational longer than you can stay solvent.”
 Robert Shiller, “How Stories Drive the Market, New York Times, January 22, 2016
 IEA (2015), Energy Statistcs of OECD Countries 2015, OECD Publishing, Paris
 James Surowieki, “Tanking,” The New Yorker, February 8 & 15, 2016, page 40.
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