Why a Steady Rise in Oil Prices Is Bullish For Stocks
While rising crude oil prices typically put a dampener on consumer spending and increase raw material costs for companies, both of which are negative for economic growth, one investment strategist argues that a steady climb in the price of the commodity could ultimately be “reflationary” and support riskier assets including equities in the U.S.
“The price of oil is never really the issue, the issue is the speed at which it advances. If the trend is gradual there could be expectations for cost-push inflation — meaning that company executives will begin to push down the higher cost of input into the higher price of goods,” Michael Gayed, Chief Investment Strategist, Pension Partners told CNBC on Friday.
He added that as long as there is no unforeseen event stemming from Iran, the move in oil prices would be gradual.
As companies sell their goods at a higher price, this will boost inflation expectations, leading more money to come out of fixed income and into stocks, Gayed said.
“While it’s painful for consumers to have oil prices rise, from a pure macro asset allocation standpoint, I would argue it’s bullish for stocks,” he said.
Gayed believes 2012 could be a year of “reflation”, when deflated prices return to a desirable level as it happened in 2003 and 2009. U.S. stocks rallied more than 40 percent during those two years.
“Given the conditions favoring inflation expectations returning to markets, and a scenario whereby money flows out of bonds and into stocks, why is it so impossible to think that an extreme move higher (in stocks) could not happen,” he said in a note.
However, he says that an unexpected spike in oil prices could drastically change this scenario, as it would not allow companies to pass on the rise in input costs to consumers leading to a deflationary impact on the U.S. economy and slower growth.
“If we woke up one morning with oil prices up 10 percent without an equal magnitude move in stocks, it would cause economic harm because there would be no ability by consumers and companies to react and adjust to the new much higher price,” he said.
Brent and Nymex crude have risen 15.7 percent and 9.8 percent, respectively since the start of the year.