Whatever happened to the cast-iron principle that high oil prices are bad for the stock market? A day after oil touched $64-per-barrel, the FTSE 100 (the index of top 100 British companies) recorded another three-year high on Tuesday.
The FTSE 250 index, supposedly a broader measure of the health of corporate Britain, is doing even better, hitting all-time highs. It is about 8% above the peak it achieved during the dotcom madness.
So what is going on? The easy part to explain is that oil producers, who benefit from high prices for their product, represent a bigger slice than ever before of the stock market.
Indeed, now that Royal Dutch Shell has a full weighting in the market indices, oil comprises more of the FTSE 100 than banks for the first time in years. Shell, BP and BG Group represent 20,7% of the value of the blue-chip index.
Then there are the mining stocks, which are enjoying the related surge in the prices of their commodity products. This sector, led by Rio Tinto, Anglo-American and BHP Billiton, represents another 5,2% of the FTSE 100.
So that’s 26% of the index that enjoys the strong prices of everything from oil to copper.
Take banks, 20,5% of the index. Their exposure is indirect, but the problem of bad loans, the theme of the past fortnight’s reporting season, can only be exacerbated as businesses and individuals face higher prices for filling lorries and cars and running offices and homes.
Then there are unambiguous losers from costly oil, like airlines, logistics firms, chemicals processors and even consumer goods businesses such as Reckitt Benckiser, who package their products in plastic.
Add up the impact on 74% of the FTSE and you have to conclude that high oil must depress corporate growth sooner or later. In other words, history is not being rewritten and the old principle still holds.
The best counter-argument is that company profitability, the hardest measure of all, is still strong. Businesses from British Airways to Reckitt have just produced solid results.
But it may just be a matter of time before reality arrives. Stephen Lewis, economist at Monument Research, points out that the response of the American consumers to rising energy payments has been to dig into savings. That sounds like trouble in store, particularly if the United States federal reserve keeps raising interest rates.
There is, of course, an even older investment principle: don’t stand in the way of a bull market. Those commodity sceptics who thought oil would never pass $50 are counting the cost of ignoring the advice.
But stock market investors should be wary: very few bull markets in shares have coincided with booming oil prices and rising US interest rates. — Â