How Do High Oil Prices Affect Stock Market Returns?

The price of oil can be extremely volatile.

In this decade alone we have seen a barrel of oil trading at a low of $37 during the pandemic and above $130 following the start of the Russia-Ukraine war.

But prices have been remarkably stable over the past few decades. Oil prices first touched 60 dollars/barrel in the summer of 2005. It was at the same level as recently as a few weeks ago.

That’s two decades lost.

Then we went to war with Iran and oil prices rose to over $90/barrel. Oil is up close to 60% this year alone and most of that growth has come since the start of the war in the Middle East.

Energy costs that rise so quickly will have an impact on companies, households, inflation and the economy.

The war caused some volatility in the markets but perhaps not as much as you might expect. The S&P 500 is down just 3.4% from its high.

Shouldn’t rising oil prices have a bigger impact on the stock market than this?

Maybe they will if the war drags on and oil prices stay high for a long time. I don’t know how long this will last.¹

If you look at the historical relationship between oil prices and stock prices, the reaction to this energy price hike is not that surprising.

I looked at the data to see how stock market returns correlate with oil price movements over the past 40 years.

What happens to stocks when oil prices rise? What happens when they fall?

You may not believe this but average returns actually are more when oil prices go up rather than down in a given year:

Here’s a look at the data for the year:

Stocks were higher when oil prices rose rather than when they fell.

Is that wrong?

It is possible.

On the other hand higher prices can indicate inflation.

On the other hand, higher prices can indicate higher economic growth.

It depends.

Yes, the current situation has nothing to do with economic growth. The geopolitical situation.

So, what is probably most important is how long this war lasts.

Chart Kid Matt looks at what happens after oil jumps 5% or more for two days in a row (which happened last week):

Most of the time stocks are higher 1, 3, 6 and 12 months later.

If the increase in oil prices outpaces the impact on the stock market it will likely be minimal.

If the battle lasts longer than expected…you will probably find a very low entry point in the stock.

We will see.

Further reading:
Geopolitics vs. Markets

¹I actually think the markets can dictate how long this takes. People hate high prices and rising gas prices are not a good look politically. That’s my opinion at least.