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Does Change In Oil Prices Impact Stock Markets?

In the world of economics, the interplay between oil prices and stock markets often takes center stage. As we know, India is a major importer of oil. And when it comes to the Indian context, it finds itself particularly vulnerable to even minor fluctuations in oil prices, which can ripple across various sectors of the economy.

Impact Of Global Price Variations

The volatile nature of stock markets, already sensitive to multiple factors like policy shifts, interest rates, and global exchange rates, also dances to the tune of global oil price variations. This volatility has prompted discussions and analysis regarding its impact on individual portfolios and the broader economic narrative in India.

Correlation Between Oil Price Fluctuations And Their Impact On Stock Market

While historical data has shown instances where significant changes in oil prices coincided with tumultuous swings in the stock market, recent studies suggest a more nuanced relationship. Contrary to popular belief, the evidence indicates that oil prices might not wield as much influence on the stock market as is commonly assumed. In essence, the correlation between these two variables doesn’t necessarily imply causation.

A key reason for this observation lies in the composition of major market indices like NASDAQ, Nifty 50, and BSE Sensex, where companies directly impacted by oil price fluctuations represent only a fraction of the overall index. Consequently, the broader market indices often remain relatively resilient in the face of oscillating oil prices, underscoring the complex dynamics at play in the global economic landscape.

Let’s delve deeper into the reasons why and how changes in oil prices can affect the stock market. Here are some such reasons:

  1. Input Costs: Numerous industries heavily rely on oil as a crucial input. When crude oil prices surge, production costs escalate, eating into profit margins and leading to a decline in the stock prices of these companies. Conversely, a drop in oil prices offers the opposite effect, bolstering profit margins and boosting stock prices.
  1. Account Deficit: With oil forming a substantial chunk of India’s imports, a rise in oil prices inflates the current account deficit by 0.55 percent for every $10 increase. This leads to an outflow of foreign exchange, causing the rupee to depreciate. Consequently, pricier imports translate to elevated input costs, ultimately driving stock prices down. Conversely, a drop in oil prices fosters cheaper imports, leading to stock price appreciation.
  1. Transportation Cost: The increase in oil costs directly influences transportation expenses. When oil prices drop, it lowers logistics costs, resulting in reduced final prices and higher demand for goods, which lifts stock prices. On the other hand, when oil prices rise, it raises production expenses, causing a negative effect on stock prices.
  1. Inflation: A $10 increase in oil prices prompts a 0.3 percent surge in the Consumer Price Index (CPI). Heightened inflation levels dent investor confidence in firms, exerting a negative influence on stock prices. On the other hand, a dip in oil prices cultivates a surge in investor confidence, contributing positively to stock prices.

 How have oil prices left their mark on the world’s stock markets?

To gain a better understanding of the relationship between oil prices and stock markets, let’s take a quick trip down memory lane to understand how oil prices have left their mark on the world’s stock markets.

Looking back in the early ’70s, between January 1973 and December 1974, major stock markets, including the UK, faced a bear run. This was a severe stock market downturn, often compared to the Great Depression. Amid various contributing factors, one of them was the oil crisis that began in October 1973. The crisis triggered a surge in oil prices and played a significant role in the stock market crash, making it a prime example of the impact of oil prices on financial markets.

Fast forward to more recent times: in April 2020, we witnessed a rather extraordinary event in the world of oil. The derivatives contracts for crude oil took a nosedive into negative territory because of the massive oversupply and a sudden drop in demand due to the global lockdown caused by the pandemic, COVID 19. Despite the dwindling demand, oil producers hesitated to cut production, hoping for a future surge in both demand and oil prices.

However, things didn’t pan out as expected. Oil prices, particularly WTI crude oil, drop into the negative, causing a stir in the financial world. Interestingly, during this extraordinary episode in oil prices, the NASDAQ index showed remarkable resilience. It only dipped by 16 points that week, and while there were some fluctuations in April, it rebounded by mid-May.

Factors Affecting Oil Prices And Stock Prices

It is necessary to make a difference between the main forces influencing corporate stock prices and those influencing oil prices. The supply and demand for goods derived from petroleum affect oil prices. Prices may rise due to greater consumption during an economic expansion, or they may decline due to increased production.

Future corporate earnings reports, intrinsic values, investor risk tolerances, and many other factors influence how much a stock is worth. Oil prices likely have a far greater impact on some industries than on others, even though stock values are frequently combined and lumped together.

What Happens In The Case Of Rise In Crude Oil Prices?

A surge in demand for crude oil in 1999 from nations like China and India caused the price of oil to rise by 215 percent in just 19 months. The Nifty saw a 43 percent increase over that time, whereas the rupee saw a 9 percent decline.

Due to tensions between the US and Iran, crude oil reached an all-time high of $145 a barrel in 2007; during that period, the Nifty fell by 4 percent while the rupee gained by 2.3 percent.

The conflict between Russia and Ukraine this year has caused the price of crude oil to rise by 85 percent in just four months. During this time, the Nifty50 and the rupee have both decreased, but not significantly.

 What Happens In The Case Of Decline In Crude Oil Prices?

Crude oil prices crashed by 77 percent between July 2008 and December 2008 as a result of the catastrophic global financial crisis, which set off a bear market. The Nifty dropped 21 percent at that moment, while the rupee lost 9 percent of its value.

Another incident in which the price of crude oil fell by 75 percent between 2014 and 2016 The rupee depreciated by more than 12 percent during that period, while the nifty fell by 2.7 percent.

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