I say so because there has for years been a positive correlation between oil price volatility (measured as the average absolute weekly price change over 26 weeks) and subsequent annual changes in the All-Share index. The correlation has been 0.12 since 1990 and 0.19 since 2000.
Such correlations might seem low. But this is because oil price volatility is usually around normal levels and so doesn't affect share prices: in fact, equity investors might not even notice it. If we look only at extreme volatility, a clearer picture emerges. Since 1990 there have been 74 weeks in which the average absolute weekly change in the oil price in the preceding 26 weeks was over 6 per cent. The All-Share index rose in the following 52 weeks on 71 of these occasions.
There might be a simple reason for this. Heightened oil price volatility creates uncertainty not just about where prices are heading, but about how to interpret them: are falling prices a good thing because they raise the real incomes of oil users, or are they a bad thing because they betoken weaker global economic activity? We know that markets hate uncertainty, so such heightened uncertainty should depress share prices. But low prices should mean higher subsequent returns for those investors brave enough to take on that uncertainty. To put this another way, volatile oil prices create a risk premium for equities.
This is consistent with some new research by economists at the University of Navarro. They've shown that share prices in G7 economies tend to fall in the month or two after oil price volatility has risen, but rise thereafter.
If all this sounds encouraging, there are two caveats. One is that, in truth, we only have a small sample. The evidence that high oil price volatility leads to rising share prices really comes only from two periods: 1990 and 2008-09. This problem, though, is unavoidable: extreme volatility, by definition, is unusual.
The other is that, on my measure, oil volatility isn't yet high enough to send a buy signal for shares: the average price change in the last 26 weeks has only been 5 per cent. This would, however, change if the heightened volatility we've seen so far this year persists. If it does so, then for longer-term investors brave enough to take on uncertainty there might just be a buying opportunity.
