Oil Prices, Developing Economies, and the Health of the Global Economy

The price of oil being positively correlated with the performance of stocks has been in the press quite a bit recently, primarily because it seems counter-intuitive to a lot of people. This seems to me to be driven by a shift in expectations around what will drive global economic growth in the medium-term. Namely, the continued growth of developing countries. 

First, we should test the hypothesis that the relationship between the price of oil and the performance of the stock market has changed. To do so, I compared the monthly change in the spot price of oil from Jan-1986 through Jan-2016 to the monthly change in level of the S&P 500 index, and repeated the comparison for Jan-1996 through Jan-2016, and finally Jan-2006 through Jan-2016. The results are summarized in the table below: 

Analysis Likelihood that relationship between changes in the price of oil and the S&P 500 is not random Percentage of the change in oil price reflected in the change in the S&P 500
1986 - 2016 39.36% (Effectively Random) N/A as relationship appears random
1996 - 2016 92.34% 5.97%
2006 - 2016 99.70% 17.22%

A couple of insights for me are that for at least the past 10 years the price of oil and the performance of the stock market have almost certainly been correlated and very positively so. With that in mind, the next question seems to be why would this be the case. The World Bank has the % of GDP made up by oil rents (think of this as the net profit of oil production) for the US at 0.9% for the period of 2011-2013 (the latest year data is available) and 0.4% - 0.7% for 1986-1990 so while oil production has become a bigger part of the US economy, that does not seem to explain most of the phenomenon.

All of this seems to point to two things; the first being that changes in demand for oil is a better indicator of changes in broad global demand and that has a direct, material impact on the health of the American economy that did not exist a couple of decades ago. Assuming that is the case I believe this changes the way we think about both our economic well-being as well as our place in the world more generally in the following ways:

  1. The return on the development of underdeveloped countries is shared between the developed world and developing countries more so than it was in the past
  2. As a result it makes sense that we  should invest both private and public funds to foster that development because if this is true for us it also true for other wealthy countries, and if we do not they will
  3. If other countries and enterprises make that investment they will reap both the economic rewards measured by this analysis, but will also likely win influence with countries that will make valuable allies over the long-run