What Does The Oil Price Mean For My Investments?
This content is for information purposes only and should not be taken as financial advice. Every effort has been made to ensure the information is correct and up-to-date at the time of writing. For personalised and regulated advice regarding your situation, please consult an independent financial adviser here at Castlegate in Grantham, Lincoln or other local offices.
Many investors will have noticed the dramatic global fall in oil price in the first quarter of 2020. On the 23rd March, the Financial Times reported the biggest drop in prices in 17 years, falling to under $25 per barrel. This might sound great for motorists here in the UK, but what does a change in the oil price actually mean for an investment portfolio? Is it good, bad or natural?
In this article, our Lincolnshire financial advisers offer some answers to these important questions. We hope you find this content useful and informative. If you would like to discuss your own financial plan, please get in touch to arrange a no-obligation consultation, at our expense:
Oil & the stock market
It would be easy to assume that a dramatic change in the price of oil also means volatility in the stock market. After all, in March 2020 the worldwide spread of COVID-19 has not only accompanied the recent drop in oil price, but also some of the worst performance on stock exchanges for many years. At the time, not only did oil fall from a high-point of nearly $65 in January, but leading indexes plummeted as the world went into lockdown; the Dow Jones fell 900 points, for instance, its worst week in 11 years.
However, it’s important to note that drops in the oil price do not necessarily mean a similar dynamic in the stock market. Researchers at the Federal Reserve Bank of Cleveland, for instance, have shown there is little historical correlation between the two. Many argue that high oil prices are detrimental to a developed economy such as the UK or the U.S. and their stocks. This is because oil prices influence the costs of production and manufacturing, which are then passed onto businesses and, ultimately, consumers. However, other price factors in the economy can, typically, offset these costs, such as wages, interest rates and technology. It is also conceivable that corporations have, overall, become more adept at reading futures markets, allowing them to change their systems and processes to make up for rising fuel costs.
Certain sectors react differently
Whilst there is no clear overall relationship between oil prices and stock prices, our financial advisers would not argue that there is no correlation at all. Specific sectors of the UK and the global economy are more exposed to fluctuating oil prices than others. Transportation and, in particular, aviation is highly affected by oil spot prices. This is largely because, for transportation businesses, the main input cost is fuel.
However, even this relationship between oil and transportation stocks can be very difficult for investors to predict. The current COVID-19 pandemic is a case in point. Quite often, a fall in oil prices would be highly beneficial for airlines, which could charge passengers the same amount for tickets and enjoy greater margins. However, currently, airlines are not reaping the benefits of the price drop. Between the 6th of January and the 16th of March, for instance, scheduled flight capacity in China changed by -38.7%; in Italy, however, the percentage was -73.9%. Fewer people are travelling by air due to lockdowns across the world, which means fewer tickets for airlines to sell.
Should you change your strategy?
Some investors might be watching the lower oil price with a keen eye. After all, isn’t there a high chance that oil prices will rise again, especially if COVID-19 lockdowns start lifting across the world? In which case, shouldn’t investors be buying more, cheaper oil shares in anticipation of this rise, to try and make some attractive returns?
Others, conversely, might be reacting in the opposite direction. Here in Lincoln, some of our financial advisers have spoken with people who want to take their investments completely out of oil companies, before things “get any worse”. Our financial planning team would caution investors against any form of timing the markets. If there’s one thing that the COVID-19 outbreak should have highlighted to investors, it’s that the markets cannot be fully or accurately predicted, on a consistent basis. Instead of focusing on short-term fluctuations in oil and stock prices, our financial advisers would recommend sticking with the long-term strategy you have established under professional advice. If you need to review your investment risk tolerance, speak with your adviser before making any big decisions which might affect the future preservation and growth of your wealth.
Moreover, it is always important to remain appropriately diversified, and the reason for this comes forth during down markets and oil price volatility. Keeping a range of assets in your portfolio (e.g. stock, bond and cash) and spreading these across multiple companies, sectors and markets will help ensure you are not overly exposed to risk in one particular area.
If you are interested in discussing your own financial plan or investment strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense: