At the end of last week, U.S. stocks dropped. Specifically, the S&P 500, an index of the 500 largest U.S. publicly traded companies, fell nearly one percent (0.92%) on Friday. Considering the positive economic news from the Federal Reserve last week, why did the week end in a slump?
Jessica Menton and Donato Mancini of the Wall Street Journal write that a chief concern has been a drop in the price of oil, writing, “U.S oil entered a bear market – a decline of more than 20% from its Oct. 3rd high . . . its longest losing streak since 1984.”
News of any commodity entering a “bear market” may create instant panic, but for veteran investors, oil is a bit different. Derek Rollingson, portfolio manager at ICON Advisors says, “I think it’s a bit of an overreaction from the stock slide relative to oil as a commodity.”
Why should investors not worry about recent drops in the price of oil? Commodity prices, such as the cost of agricultural goods, often fall because consumer demand has fallen, and drops in demand can highlight consumer’s inability to pay for goods and thus a weak economy. However, it is not likely that current drops in oil prices are the result of weak demand. Instead, this drop is the result of excess supply in the market. Excess supply of oil is due to global politics.
Here’s how it happened: several countries, including Saudi Arabia, expected U.S. sanctions to restrict Iran’s ability to export oil. So these countries increased oil production to compensate. However, when Secretary of State, Michael Pompeo, reported on November 2 that the U.S. “expect[s] to issues some temporary allotments to eight jurisdictions” allowing for Iran to export oil, it was too late for countries like Saudi Arabia to cut back increases in oil production. The excess supply of oil means that producers have more pressure to get rid of supply, which increases consumer’s purchasing power.
What does this story mean for U.S. investors? Of course, energy focused companies may lose revenue from having to sell oil at a lower price. But more importantly, this story tells of a U.S. economy that is, for better or worse, increasingly bound to the outcomes of global politics.