Significantly lower real oil prices support the stock market boom
The first graph shows the nominal and the real price for a barrel of crude oil, using the Bloomberg Inflation Adjusted WTI Crude Oil Spot Price Index. From a long-term perspective, the difference between nominal and real prices is significant – to a degree that even the chart may not be able to appropriately visualize.
Specifically, at the end of January, the nominal oil price was around $48 – i.e. it was still almost 60% higher than in May 1983 (start of index series). However, in real terms, it had slumped to about $20 – or 33% lower than in 1983. This shows how much oil has dropped in relation to the general price level in the economy, from a US viewpoint. That decline clearly offers a tailwind for consumers as well as many companies in various industries.
Oil prices have collapsed and earnings have soared but real stock prices are still at 2000 levels
The next graph shows the real price of the S&P 500 (based on data by Prof. Robert Shiller) and the real oil price. The great bull market of 1980-2000 gained momentum after a similarly significant drop in oil, which had peaked at about $100 in 1980. With the stabilization of oil prices at a low level in 1983, the equity market started to gain upward momentum, and it finally entered a phase of “irrational exuberance” more than a decade later, in the second half of 1990s. Equities were very volatile after 2000, going through two intense bear markets, and two bull markets, the second of which began in 2009.
It is important to note that, despite this rally, in inflation-adjusted terms, US stocks have only recently reached the 2000 levels – even though corporate profits and dividends have by now surpassed the equivalent highs by 45% and 75%, respectively (also adjusted for inflation). The latter point also distinguishes the current bull market phase from the extreme rally in the late 1990s, when earnings and dividends lagged stock price gains for many years.
Going forward, admittedly, it is reasonable to expect that US stocks will not continue to outperform as strongly and as consistently as they have since March 2009 – other markets will eventually start catching up, just like Eurozone equities began outperforming earlier this year. At the same time, in terms of direction, it could very well be that the current US bull markets will last for many more years.