Back in Feb 2013 we introduced the "Brent Vigilantes" and reminded traders how stock markets (and macro economies) react to shifts in the oil price with the two trading together to a 'tipping point' at which point strocks belief in growth breaks. We further confirmed that this is even more worrisome in the case of an oil price shock which strongly suggests that VIX at 12 is not pricing in the volatility that we have seen in the past when the oil complex starts to shake.
We detailed in Feb 2013 how oil's trigger points drives macro weakness,
Time and again in the last few years, even as central bank balance sheets have risen inexorably, we get corrections in equity markets that bring them back to a fundamental reality, however briefly. The catalyst for those 'corrections' is hard to pin-point but a step back and we see that the flood of new money also spills out to anything that can't be printed (gold, silver, oil) and it is the latter that has a natural drag on the global economy. So, while the 'wealth' transmission mechanism is now the only policy tool left for central banks, it is the price of Oil that caps that upside thanks to its impact at the margin of a fragile global economy.
Nowhere is this more clear than in Europe, where each time Brent crosses above $120 (helped by central bank largesse), macro-economic surprises start to deteriorate rapidly and markets fade. We are close to $120 (Brent) once again now... With government bonds in US and Europe 'managed' so well, the vigilantes have left the building - and moved to the Crude oil pits...
The same is evident in the US - with $100 WTI apparently the trigger...
The jury is still out on whether the US will attack Syria, whether it will do it unilaterally or as part of a coalition (with France), and how far crude would spike in the case of an intervention. Previously, SocGen presented some apocalyptic (if brief) scenarios that saw oil soar all the way to $150. That may be a stretch, but once the Tomahawks start flying a jump in Brent is virtually assured. Here is what BofA says on the matter: "watch for any escalation of Syria/geopolitical tensions that send Brent oil prices in excess of $125/barrel, the level in 2008, 2011 and 2012 that helped trigger a correction in equities. Historically during oil price spikes, equities have underperformed bonds, which have underperformed cash."
So what would happen to stocks? The mainstream financial media, in order to preserve a sense of calm, took the blended average of equity returns following historical oil price spikes, and concluded that it would be a manageable -2% in the worst case. However, like in the Reinhart-Rogoff case, the average calculation is a function of very disparate value, ranging from -15.5% in the case of the Iraq-Kuwait war of 1990 in the worst case, to +12.9% in the case of the Iran-Iraq war of 1980.
In other words, assuming a simple blended average return based on historical results is the most flawed approach in a military conflict that is and will be as unique, as all previous petrodollar conflicts have been in the past.
And speaking of historical results, here is what the record books say:
So the next time some talking head proclaims that stocks and oil rise together and so $120/130/140 oil is no problem for the US/EU/Chinese economy, remind them of these charts!!!
Because, as is clear below, high oil prices bleed into high gas prices and tamp the US consumer-driven multiple expansion exuberance
Each time retail gas prices have topped $3.80, valuations (Fwd P/E) have also topped - not good news for a market driven solely by hope-driven multiple expansion...