How oil holds the key to whether the stock market has bottomed

They say Helen of Troy is the face that launched a thousand ships. Well, the question “have we bottomed yet?” has launched a thousand articles. Or it feels that way, at least.

Sometimes humans have a habit of overcomplicating things, so let’s try to strip this down to the basics here. We have a few factors in play, which make the current economic situation relatively unique (I gave up using the phrase “unprecedented times” after every news anchor on every station used it daily during the pandemic).


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  • Geopolitical situation (Russian war, oil sanctions etc)
  • Fed hiking rates
  • Inflation
  • The thought that we are “due” a correction following a historic bull-run of over a decade

Geopolitics

Let’s keep this quick. Russia invading Ukraine is still something I’m struggling to get over – a war in Europe in 2022? It’s heartbreaking and sad and shouldn’t be happening, but it also makes it impossible to predict what will happen next in the markets.

The knock-on effect in terms of economic sanctions, potential further Russian aggression and externalities in the commodity and oil markets have pulled markets down. But how is a kid on a laptop meant to predict what Putin does next?

The reality is that nobody knows. Is there a chance that he pulls out sooner than anticipated and all the aforementioned factors magically “fix”? Unlikely, but I suppose it’s possible. Then again, we are now over 100 days into this tragedy with no sign of respite, and it could easily go the other way. Markets are accordingly volatile and jittery, and for the time being I’m operating on the assumption that nothing changes here.

Fed Hiking Rates and Inflation

It’s Jerome Powell’s world, and we’re all just living in it. Or at least it feels that way. The much-discussed Fed chairman can move markets on a single word, and right now the scale of hikes anticipated is ugly, with a recession seemingly inevitable.

But that doesn’t mean we haven’t necessarily bottomed. Stocks have plummeted quicker than my respect for Kylian Mpabbé (seriously, holding your own club to ransom? Come on). We are now at a point where the S&P 500 is down 14% YTD and the Nasdaq is off 23%.

I thought Gina Sanchez, CEO of Chantico Global and CMO of Lido Advisors, had some interesting thoughts on this when she went on CNBC this morning.

The Fed is largely priced in, if you look at where the S&P has gone. The problem with all of the Fed stimulus over the last two decades is that it didn’t find its way into inflation until just recently; it found its way into asset price inflation

Gina Sanchez

She also mentioned the average P/E ratios have dipped from 20 to 18. So, it kind of feels like we have this baked in – especially when looking historically at how valuations have shifted in previous recessionary periods. At this point, we know the Fed is hiking, and the news this morning that ECB confirmed a 25 bp hike at next month’s meeting only solidifies that further. I tend to lean towards Sanchez’s opinion here, in that we can now box off potential hikes as bearish factor – the market has already reacted accordingly.

Oil

Oil, on the other hand, is not so certain – taking us back to forecasting Putin’s actions above. And while Russia continues to wage its war on Ukraine, eyes in the oil world then pass to the Saudis, who suddenly hold the key, amid ongoing sanctions on Russia.  

Joe Biden even plans to visit Saudi Arabia this summer in a bid to whisper sweet nothings in the Saudi princes’ ears, highlighting the quagmire we are in. The effect of oil can’t be understated – its rocketing price has essentially taken the form of a tax, pulling money out of the economy and depressing consumer sentiment. Take a look at the below graph, if you’re one of those visual people and don’t want to hear me harp on.

If the Saudis and OPEC+ control the supply right now, the demand side has been all over the shop because of China. Its zero-COVID lockdown policies and heavy reliance on external suppliers have caused the demand side of the market to yo-yo all year, given that they have, well, a lot of people who need a lot of energy. China re-opening when oil prices are already north of $100 a barrel wasn’t exactly good news for anyone who likes driving cars, heating their homes or enjoying electricity – which last time I checked was a substantial portion of the world.

So there are a couple of variables here that make predicting the oil market rather difficult.

The outlook (for oil prices) looks terrible… oil prices were high before China started re-opening. Then they began to re-open and it started putting even more pressure on oil. We are doing this at a time when the supply chains were already constrained because of pandemic-related labour shortages … this was a real challenge and bringing supply online is going to take time

Gina Sanchez

Conclusion

Sanchez goes on to assert that while the stock market has already priced in a lot of negative news and that she doesn’t see P/E valuations getting back to the 16X level we saw pre-GFC (currently 18), there may be further volatility to the downside in the short-term.

I tend to agree. Which takes me to the final factor above, which you may have noticed I omitted – this concept that we are “due” a correction. That has now happened – we are no longer seeing shitcoin screenshots of 1000X circulate on Twitter, nor are NFTs going for the millions of dollars on the daily any longer. The froth has been blown off and the sentiment is now extreme fear, which tends to happen when the stock market plunges 20%.

My gut feel is that most of the madness is over, or that’s certainly what I’m telling myself as I cry myself to sleep each night at the state of my portfolio now compared to six months ago. Sure, I’m with Sanchez in that we may see further dips as the market overshoots the “fair” value, but trying to predict those takes me back to what I asserted earlier – unless you have a direct line to Putin, the Saudi offices or the Chinese administration, that’s a fool’s game.

The majority of the damage may be done, but for the time being I’m still sitting in stablecoins and low-risk assets, for a while longer at least until we get a little more clarity from the geopolitical generals.

The market humbles you. That’s never been more true. Strap in.

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Source: https://invezz.com/news/2022/06/09/how-oil-holds-the-key-to-whether-the-stock-market-has-bottomed/