The first step is to build a model framework for the S&P500. Our model framework reveals that the 'classical' or long-term (since 1948) relationship between equities and energy prices is one where lower oil prices is a positive factor for the equities market. It also reveals that from 2000 until recently a 'super-cycle' regime evolved where higher oil prices for a period became a positive driver of the S&P500.
The second step is to build scenarios for future developments in the oil price. In our base case, the oil price (Brent) will slide from the current level around USD106/bbl to USD90/bbl by end-2014. The main reason is a global supply shock.
In the third step, we evaluate the scenarios from step 2 using the model framework developed in step 1. We argue that we are currently on our way back to the 'classical' model where a lower oil price is a positive factor for the equities market. The most important evidence in this respect is that the profit cycle has continued to strengthen since 2011 despite weaker commodities prices.
Our conclusions are as follows. Based on our base case for the oil price and assuming a return to a 'classical' relationship between the oil price and the stock market, we find the equity market is in balance around the current market level of 1,650. Notably, the oil price is likely to have to fall below USD90/bbl to drive the S&P500 above 1,750. We expect consumer discretionary industries such as autos and household goods to benefit the most in our base scenario.
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Equities And Commodities: Return To The 'Classical' Regime
Published 07/12/2013, 07:37 AM
Updated 05/14/2017, 06:45 AM
Equities And Commodities: Return To The 'Classical' Regime
In this document, we investigate the relationship between oil prices and the equity market. For the past decade, it appears equities and oil prices have related positively, contrary to the classical idea that higher commodity prices drive up input costs for most companies, thus weighing on stocks' performances. What will the relationship be between the equity and commodity markets going forward? To answer this question, we proceed in three steps.
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