Equity investors shouldn't worry much about higher oil prices, according to new research. Stephen M Miller of the University of Nevada, Las Vegas, and Nicolas Apergis of the University of Piraeus, have found that "oil market shocks exert a minor influence on stock markets".
You might expect this if oil rises because of a stronger world economy. In such cases, the adverse effect of higher oil costs on corporate earnings is offset by the benefit of increased demand, leaving shares unaffected.
However, Messrs Apergis and Miller estimate that variations in global economic activity explain only a small part of the variation in oil prices. And even controlling for that, oil prices still have little effect upon shares. Between 1981 and 2007, they calculate that changes in oil prices accounted for only around 10 per cent of the variation in equity returns in eight major markets.
They did, however, find that increases in oil prices beyond what one would expect given the state of the world economy tended to lead to lower share prices in the UK and US. But this effect is small.
This raises a paradox. Big rises in oil prices have led to recessions, as in the early and late 1970s. So how can they not affect share prices?
Partly, it's because shares and oil prices are both volatile, and it's hard to find strong relationships in noisy data. Also, although big rises in oil prices lead to recession, smaller rises have less obvious effects. But such smaller rises are much more common.
Thirdly, the fact that higher oil prices lead to recessions is irrelevant for shares - at least for a while - if investors don't believe they do. We know in hindsight that rising oil prices in 2005-07 led to recession. But few investors knew this at the time, so share prices stayed high, leaving little discernable relationship between oil and equities.
