Oil has been on a lot of investors’ minds lately. Last fall’s precipitous drop caught many by surprise, and since then oil has continued down its sliding trajectory, now hovering around the lowest level in more than five years. As I have discussed in recent blog posts and more in depth in my latest Market Perspectives paper, The Oil Plunge: The Outlook for and Impact of Lower Oil Prices, I expect oil markets to remain volatile and prices to stay low in 2015. Cheaper oil represents a significant shift in the investment climate, though for the most part it is a welcome one.
Why did oil prices fall? The oil plunge was a function of three developments: weakening global demand, a surge in U.S. production and surprisingly resilient supply out of the Middle East. A stronger U.S. dollar also contributed, since by definition that affects demand for dollar-denominated commodities.
For 2015, we anticipate more big fluctuations, but with the potential for a two-way market should Middle Eastern production or exports falter. Although lower prices will ultimately lead to some adjustment in U.S. production, current levels are unlikely to lead to an immediate cutback in U.S. shale production. However, they are likely to impact future exploration.
In terms of the implications of lower oil prices, while the collapse in oil helped produce a short-lived but still meaningful market correction, we believe lower oil prices are supportive of the global economy. Lower oil is a de facto tax cut for Western consumers and, while it will be detrimental to some emerging market countries, it will likely benefit others, particularly those that subsidize energy prices. On the other hand, resource-dependent economies will struggle with making lower prices work.
We don’t believe that lower oil prices pose a fundamental threat to equities; energy accounts for a relatively small weight in most equity indices. In addition, consumer stocks, a larger portion of most equity benchmarks, are likely to be net beneficiaries of lower oil prices.
But falling oil prices are having a more mixed impact on bonds. Lower energy prices are helping to reduce inflation and dampen inflation volatility, particularly in the United States. However, lower energy prices are causing some distress in several smaller high yield issuers, putting some pressure on that segment of the market.