How The Oil Price Decline Will Bring Catastrophe To The Stock Market - Alldamoney

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How The Oil Price Decline Will Bring Catastrophe To The Stock Market

The continual drop in oil price has prompted many analysts to try and understand how it could affect the stock market (U.S. crude for September delivery dropped below $40 a barrel on Tuesday, marking it the lowest close since April and the 10th decline in 12 trading sessions, before rebounding to end the week at $41.80. Oil has slipped 18% down since early June) but to the surprise of many there is little correlation between the two according to a Research by the Federal Reserve Bank of Cleveland who examined the movements in the price of oil and stock prices. The result of this study came up with not only low but declining correlation between the two which concludes that analysts cannot really predict the way stocks react to changing oil prices.

A distinction needs to be drawn between the primary drivers of oil prices and the drivers of corporate stock prices Oil prices. Oil prices are determined by the supply and demand for petroleum-based products. Prices of oil might rise as a result of increased consumption or they might fall as a result of a decrease in production.
Stock prices rise and fall based on future corporate earnings reports, intrinsic values, investor risk tolerances and a large number of other factors.
A falling oil price is assumed to be good for consumers and businesses, leaving them with more money to spend on other goods and services. But an oil price declines could weigh on oil stocks which would impact on corporate earnings therefore on their stock prices.And all this could spread to other sectors just as witnessed earlier this year where it came out clear that unrest in one asset can quickly bleed into another.
So do Oil Really Drive Stock Prices?
There are several likely explanations to why there is no strong correlation between stock market and oil prices as stated by research
The first and most obvious is, there are lots of factor prices in the economy, such as wages, interest rates, industrial metals, plastic and computer technology, which can offset changes in energy costs. Another possibility is that corporations have become increasingly sophisticated at reading futures markets and are better able to anticipate shifts in factor prices; a firm should be able to switch production processes to compensate for added fuel costs. Some economists suggest that general stock prices often rise on the expectation of an increase in the quantity of money, which occurs independently of oil prices.

So far, stocks and other riskier assets mostly are holding up. Though the Dow Jones Industrial Average fell for seven straight trading days through Tuesday, its longest such streak in a year, it remains just 0.3% below its all-time closing high reached on July 20, after rising 191.48 points, or 1%, to 18543.53 on Friday. But some money managers fear tumbling oil prices will erode investor sentiment and spread to other markets from U.S. stocks to riskier bonds.

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