Oil Prices: An example of Market Indicator or of Market Randomness?

Oil Prices: An example of Market Indicator or of Market Randomness?

There is plenty of discussion as to what has been happening with oil prices. When the cost of a barrel of oil sank from $76 to under $50 in October 2018, a cacophony of thoughts, theories, and predictions from investors began to fly. What was going on? Are we heading towards a sluggish economy? Are we making more oil? Less oil? The Farmer’s Almanac is calling for a mild winter season. Is that it?

Looking at how quickly things took a dip, it can be simple to say that it snuck up on us. It came out of the clear blue. Right? Well, maybe not.

Historical Ebbs, Flows, and Hiccups

Considering long-term trends in pricing, we can see that since early 2008, oil prices have been trending downward. Oil hit a peak price in June 2008 of a little over $160 a barrel. This was swiftly followed by an 18-month plunge that left prices around $56 a barrel. Boom. The price would occasionally scratch its way back up to $110 or $120 here and there, but pullbacks would widdle it back down again.

Oil prices have consistently been under $100 a barrel since the summer of 2004, hitting a bottom of $36 a barrel in January of 2016. Prices have been petering up since then, but never breaking through the $80 a barrel price point.

All of this is good for consumers and the transportation industry, but it leaves the energy sector in the dust within an otherwise robust market. If we look at the Energy sector for the last decade, it’s apparent.

  • Through November 2018, the Energy sector lost about 24% for the 5-year period. (The 3-year number is just in positive territory)
  • When evaluating the 11 sectors of the S&P 500, the Energy sector was the weakest performer.
  • Through November 30, 2018, the Energy sector lost about 10% for the 1-year period.

Clearly, the Energy sector has had a rough go of it while the rest of the market

Radomness is just that. Random.

The wormhole of oil prices is a clear example of the indiscriminate nature that exists in the markets. We like to think that there is some 1 + 1 =2 order to the markets; that there are reasons and patterns behind the way markets progress. That fact is that this is simply not true all of the time and we will not always have clear indicators of what, how, or how quickly things can move.

Scholar Nassim Taleb writes in his book, Antifragile: Things that Gain From Disorder, that sometimes the appearance of market stability and an impervious nature can be just the thing to spring a rapid market change. Taleb writes, “Our minds are in the business of turning history into something smooth and linear, which makes us underestimate randomness. But when we see it, we fear it and overreact.”

Could this kind of reaction be what’s causing oil prices to dip below $50 a barrel in 2018? It’s hard to say.

It’s certainly challenging to postulate the correct price for a commodity like oil. When the markets decide to make a switch in trend, don’t expect to receive indicators that something is coming down the pike. The fact is that the markets have randomness embedded in them with unrecognized and underappreciated significances that drive changes in direction.

The bottom line is that there is a lot of noise out there. There are pushes and pulls, unknowns and certainties, and human responses that play into the hodge-podge that make up the markets. We won’t know precisely what the markets will hand us, but we can do our best to make educated choices that protect us as much as possible and move us in the direction we wish. Take the time to enlist the help of a fiduciary financial planner to help you stay the course.

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