Is the Current Volatility About the Global Energy Crisis?

This morning, pundits are looking for reasons to explain the weakness in the premarket, and they are blaming oil’s recent push to multi-year highs and the global energy crisis. That sounds right and fits with the conventional wisdom that higher energy prices are bad for the stock market, but does that really explain what is happening?

In financial markets, conventional wisdoms are dangerous things. Just because something happens often enough and over a long enough period of time, becoming an accepted pattern, doesn’t mean that it will always happen. Most of us who follow markets have been made acutely aware of that over the last decade or so, as recovery from a financial crisis and unprecedented central bank policy have distorted the major markets.

The word “distorted” is emotive, of course, but in this case, doesn’t necessarily imply criticism. A zero-interest rate policy (ZIRP) and asset purchases (QE) were needed responses by central banks around the world to a liquidity crisis that threatened the global financial system. So the distortion can therefore be seen as a price worth paying. Those policies have, however, destroyed some accepted relationships between assets.

In theory, bond yields and stocks move in the same direction, and yet we have seen an extended period of lower yields and higher stocks as the Fed and other central banks have created simultaneous demand for all asset classes. Banks and institutional investors no longer have to choose between stocks and bonds based on their expectations for economic conditions. When they can borrow at essentially zero and are being handed newly created cash every month, they can simply buy everything, pushing yields lower as stocks rise.

Similarly, in a world awash with cash, other markets have exhibited gains that aren’t reflective of “value” in any real sense. Bitcoin and NFTs may have made gains in other conditions, but would pricing of assets like those be where they are without massive liquidity in the system? I doubt it.

It stands to reason that if digital assets are trading at levels unrelated to value in a conventional sense, then real ones, including oil, probably are too. Admittedly, there are also some exceptional circumstances on the supply side of the pricing equation there, with OPEC+ restricting output and U.S. oil companies hesitant to fill the gap in an unfriendly regulatory environment. But the price of crude right now tells us nothing about expectations for the economy, nor is it a major factor in equity pricing. As hard as it is for those trained in market theory to accept, the price of every asset is now distorted, so reading too much into the cause and possible effects of moves in any one is dangerous.

That same distortion, or more accurately the Fed’s stated intention of ending it, is far more influential on stock prices right now than the price of oil or a temporary disruption of energy supply. Investors are once again faced with choosing between stocks, bonds and cash. As those choices are being made, we are seeing stocks and bond yields once again moving in opposite directions. This time yields are rising as stocks are falling, but again, those moves are about liquidity, not the economy, and certainly not energy.

For weeks now, I have been hearing from friends and family in the U.K. about lines at gas stations, often miles long, when a delivery of fuel is expected or rumored, but I haven’t given it much thought in terms of its possible impact on U.S. equities. It is a product of a unique set of circumstances, with Brexit being a major one, and therefore hasn’t impacted asset pricing here in any way. That has been the case for a month or so, and is still the case today, even if some would have you believe otherwise.

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