The UP Side of DOWN Oil

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Does lower oil mean lower stock prices?

The drop in the price of oil may not be good for oil related companies nor the communities that rely on oil production and services to fuel their local economy. But there may be some positives to cheaper oil that you may not have considered.

I came across an interesting chart yesterday that shows what happened to the S&P 500 stock index after oil dropped by more than 50%. The chart goes back over 30 years and shows that the type of decline that we are seeing in oil has happened four times in that 30 year period.

Interestingly, the average annual return of the S&P 500 one year after each of these drops in oil is a gain of 24% for stocks. 

Take a look at this chart from First Trust Portfolios (and be sure to read all of the disclaimers at the bottom of the chart, which I endorse as well). 

This seems like the opposite reaction that the financial media have been suggesting lately. Why has this positive reaction of stocks happened previously when oil falls? A few reasons are that companies who rely on oil have to pay less for this vital commodity. That leads to more profits. Think of airlines. One of their largest expenses is the cost of fuel. If ticket prices remain constant then lower oil means more profit margin for the airline. 

And, it should be obvious to all that the consumer benefits at the pump by paying lower gasoline prices. That's an instant pay raise for most people, a pay raise that they can use to buy other things besides gas. Here's what JP Morgan says* about consumer behavior due to lower gasoline prices:

“Consumers report that they are using their gains at the pump to pay down debts and save. Individuals spent 78 cents of every dollar saved on gasoline, with about 18% of that going to eating out and 10% to groceries, according to the study. Other big categories included entertainment, electronics and appliances, and charitable donations".

No one can say for sure if this most recent drop in oil will lead to a rising stock market. But, if history is any guide, lower oil could be good for the stock market and your wallet.