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Surging oil prices dent economic activity and fuel inflation, but are not necessarily bad for stock markets.

A look at four previous major oil shocks - 1974, 1979, 1990 and 2000 - suggests it is a brave investor who bets with any certainty how equities will react over the coming year to the current surge in energy prices.

Right now, it may seem obvious: sky-high oil is stoking the strongest inflation in decades, the Federal Reserve is bent on jacking up interest rates, economic growth is slowing, consumers are being squeezed and corporate profits will surely suffer.

How can stocks emerge from that unscathed, especially with war breaking out in Europe and global geopolitical stability suddenly at its most precarious in decades?

Citi research shows that world stocks fell 30 per cent in the 12 months after the 1974 and 2000 oil peaks, but rose 10 per cent in the year following the 1979 and 1990 shocks. They define an oil shock as the price of Brent crude at least doubling its three-year moving average.


Brent was hovering just under US$100 a barrel on Feb. 23, the day before Russia invaded Ukraine, and averaged around US$60/bbl in the previous three years. It spiked to US$139/bbl on March 7, and remains around US$120/bbl.

Citi’s analysts say there is no clear explanation for this, but suggest some reasons why equities might break higher this time around.

One is the relative strength of the U.S. economy. In these past four oil shocks, the ISM index of non-services activity plunged below 50 and was followed by recession.

That index in February was at 58.6, a much higher starting point than the average 52.3 over the previous four episodes. Most economists still expect U.S. gross domestic product to grow more than 3 per cent this year, which should provide a decent backdrop for continued, if slowing, earnings growth.

Another is negative real interest rates. Even though the Fed is slamming its foot on the policy tightening pedal, annual consumer price inflation of almost 8 per cent means real rates will likely stay below zero well into next year.

Negative real rates gave a huge boost to global equities during the COVID-19 pandemic shutdown. In 2020 the MSCI world benchmark index rose 15 per cent, despite a 22-per-cent drop in earnings per share.

Many investors may also hold their noses and buy stocks simply because they are not bonds, as fixed income assets around the world get crushed by the weight of rising inflation and interest rate expectations.

U.S. Treasuries are having their worst month since 2009 and are on course for their worst quarter in at least 25 years. That makes them cheaper, but Wall Street’s 10-per-cent bounce off its lows suggests investors still prefer equities.

“Bonds just do not look like an attractive option this time round, especially for those investors worried about higher inflation. Maybe ... there still is no alternative to owning equities,” Citi wrote on Monday.


U.S. stocks are still more expensive than they were during the 1990 oil shock, but much cheaper than in 2000.

The energy sector’s weighting in the S&P 500 is less than 4 per cent, down from around 6 per cent in 2000, 10 per cent in 1990 and almost 25 per cent in 1979.

Lastly, the U.S. economy is simply far less vulnerable to expensive oil than it was in the past.

Commerce Department data show that spending on energy goods and services in 1970 was around 6.5 per cent of total consumer spending, and more than 9 per cent in the early 1980s. In January it was 4.2 per cent.

Bruce Galloway at Galloway Capital Partners in Miami notes that in the late 1970s the U.S. economy consumed an average of nearly 19 million barrels of oil a day. Almost half of that was imported, and annual GDP was barely US$3-trillion.

Today, oil consumption is broadly the same, yet the economy is nearly 10 times bigger and almost entirely energy self-sufficient.

“We are way less dependent on oil today, we are way more efficient. The oil price increase is trivial compared to home equity gains in recent years which are worth trillions. People are feeling good, even though oil prices are going up,” he said.

U.S. consumers are grappling with the highest nominal average gasoline prices on record above US$4.30 a gallon, which automobile club AAA warns could reach US$7 a gallon if crude hits US$200/bbl.

But as former Treasury Secretary Larry Summers said at an Economic Club of New York event on Tuesday: “Even if oil prices go to $200 a barrel, the price of driving a mile will not be higher than it was in the 1970s because cars are much more fuel efficient and because of the inflation that’s taken place since that time.”

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