One does not need explicit signs of demand growth or supply disruptions, the smell of it will tempt battered bulls to get back into the market. Despite the ceasefire agreement between Israel and Hezbollah brokered by the US last Monday and which came into effect a week ago the warring parties exchanged fire and traded accusations of breaching the truce.  It was a good enough excuse to cover some short positions. Yesterday’s jump was a decent recovery, also caused by the Syrian opposition taking the town of Aleppo. Yet, it is worth remembering that Brent, for example, is still a good dollar away from the pre-ceasefire peak. 

Further support came from OPEC+. The whisper in the corridors of the OPEC headquarters in Vienna is that the planned tapering of voluntary output constraints will once again be pushed back. One cannot help but ponder how long the organization and its members are willing to sacrifice market share, both external and internal, on a seemingly dubious and chiefly ineffective project of supporting oil prices. On the other hand, it is obvious, which direction prices would be heading when extra barrels hit the market.

The political unrest in South Korea, the imposition and then the lifting of martial law has shaken Asian markets this morning but is being largely overlooked in oil. So is last night’s API report, which showed builds across the board: 1.2 million bbls in crude, 4.6 million bbls in gasoline and 1 million bbls in distillate stocks. The US labour market is solid; job openings were steady in October and layoffs fell. Investor mood has unambiguously brightened, and market sentiment should never be underestimated. Yesterday’s rally could have some way to go, but neither geopolitics and OPEC+ action nor sanguine financial data will alter the underlying fundamental outlook. Protracted attempts to push oil towards $80/bbl will be reined in by supply checks and loose oil balances.

US Equity Market Bubble Keeps Growing

It is a statistical fact that the close relationship between oil demand and prices has been falling apart for quite some time now. Up until around 2015, when US shale production took off in earnest, oil prices closely followed the changes in oil demand. The correlation between these two variables stood at over 90% between 1994 and 2014, based on IEA data. (OPEC and the EIA show similar outcomes.) In the subsequent 10 years, there was a great amount of love lost between the two. Since 2014 throughout 2023 consumption grew from 92.8 mbpd to 101.9 mbpd worldwide. This increase of nearly 10% was coupled with the average annual Brent price falling from $92.91/bbl to $77.60/bbl.

Demand is hugely influenced by the economy's performance, which, in turn, is mirrored in stock markets. Although the supply side of the oil equation has been playing an increasing role in the formation of oil prices, it would be foolish to believe that the demand side can be neglected and consequently equity markets can be ignored. A healthy economy and a burgeoning stock market boost oil demand and even if they do not support prices explicitly, they mitigate the negative price impact of the ever-growing supply.

It leads us to the recent stellar showing of the US equity market. It has overwhelmed its peers and undeniably echoes a strong economic backdrop, which inevitably supports oil consumption in the world’s biggest economy. The de-coupling from the rest of the world is, in fact, so significant, that the question must be asked: is the current trajectory sustainable for the medium to long-term or is there a bubble being inflated and is it a matter of when, and not if that it will burst or at least deflate?

The exceptional stock market rally in the US rests on numerous legs. To begin with, it was the US that reacted quickest to the Covid-19 pandemic by cutting interest rates, as opposed to China, which was dragging its feet for years. Because of its fair distance from Russia, it was less exposed to the inflationary pressure of the Ukrainian conflict than Europe, not to mention its growing energy independence. Its regulatory environment, which supports innovation, the astronomical rise of artificial intelligence and the Biden administration's stimulus measures have all aided the stock market rally. Since March 2020, when the recovery from the pandemic-induced devastation began the MSCI All-Country Index advanced 128%, which pales in comparison with the jump of 165% in the S&P 500 Index or the nearly tripling of value in the Nasdaq Composite Index.

Outperforming peers is one thing, overshooting fair value is quite another. As convincingly argued in an opinion piece in the Financial Times, this widening chasm must narrow at some point in the foreseeable future. The relative strength of the US equity market, which now makes up nearly 70% of the leading global stock index, up from 30% 40 years ago, is not justified by the country’s share of the global economy (27%). The disproportionate robustness is chiefly the product of the initial enthusiasm for Trump’s tax cut pledges and his plans for a regulatory overhaul. Moreover, insatiable investor’s appetite for only a handful of technological stocks and the resultant realignment of funds from global markets into the US are also contributing factors. As the FT piece puts it, ‘In the past, a rising US market would lift other markets. Today, it is sucking money out of it’. It creates headwinds for smaller economies, weakens their currencies (the dollar index has risen from 89 to 106 since 2021) and might force central banks to raise interest rates.

Protectionist US economic policies do not fully inoculate the country against external forces. The US will remain a sizeable part of the global trade (albeit to a lesser extent than pre-Trump). A correction is inevitable, its trigger and timing are equivocal. Whether it will come in the form of a stock market crash or just the narrowing of the gap between the US and other equity markets remains to be seen. The transactional incoming US president is conscious of the performance of the stock market and in case it shows signs of weakness he might backtrack on his inflationary policies. As pointed out at the beginning of this report, oil is preoccupied with the loosening of the oil balance precipitated by ample supply. Nonetheless, a retreat in the US equity sector will do nothing to tighten this balance and brighten the mood. The resilient dollar will remain strong as its safe haven status will come to the fore. The outsized dominance of the US economy and stocks have failed to help oil meaningfully challenge its recent peaks. A retreat, in whichever shape or form it comes, will be even less able to do so.
 

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