Oil Prices may have major impact on stocks soon

While no one was paying attention, crude oil prices quietly fell by over 11% since the beginning of August. You can only imagine what an uproar the financial media would be in if major stock indexes gave up that much ground in a little over two weeks.

What's more, if measured from the peak spike in oil prices following the US attack on Iran's nuclear facilities on June 22, at $78.40, the decline is even greater, at over 20%—bear market territory.

Meanwhile, major stock market indexes, like the SPDR S&P500 ETF Trust and the global iShares MSCI ACWI ETF Index, have continued to hover near all-time highs, with little sign of imminent downside.

Let's take a closer look at what's driving lower oil prices and its implications for stock market prices.

Oil prices have tumbled over 10% in August.

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Oil prices are a leading indicator of energy demand

While oil is subject to myriad factors driving its price, a number of key relationships exist between oil and other global markets.

The most important economic linkage is that oil prices serve as a proxy for overall energy demand. Global energy demand, in turn, is greatly influenced by global economic growth conditions and expectations.

It's worth noting that oil is a finely balanced market that is subject to extreme price shocks from incoming news, such as geopolitical crises or attacks on oil infrastructure.

From a tactical perspective, such price dislocations can give active investors opportunities to buy at price levels they may not see again. However, given this year's choppy environment, lower prices speak to using limit orders to limit losses rather than buying or selling at the market.

Global demand is key to what's next for prices

While not likely to trigger a price spike because there is no single indicator to pinpoint, global demand is best gauged by considering several key indicators, such as GDP, ISM manufacturing data, and OECD world economic forecasts.

Unfortunately, those indicators have been moving in a southerly direction in recent months.

OECD GDP estimates paint a picture of a weakening global economy.

OECD/TheStreet.com/Brian Dolan

US real GDP is currently forecast at 2.5% annualized for Q3, down from 2.6% month-ago levels, according to the Atlanta Fed's GDPNow indicator.

Separately, as seen in the chart above, the Organization for Economic Cooperation and Development (OECD) forecasts only 1.6% GDP growth for the US in 2025 after 2.8% in 2024.

The OECD data for other key economies is similar:

Eurozone growth is expected to remain anemic at 1% (down from the December 2024 forecast of 1.3%).
China is expected to post 4.8% GDP growth, which is down slightly from month-ago levels of 4.9%, and, crucially, below the government's target of 5.0% annual GDP growth.

ISM manufacturing indexes are also worrisome:

US and European manufacturing ISM indexes remain in contractionary territory at 48 in July (down from 49 prior) and at 49.8 (unchanged) in August, respectively.

While ISM headline numbers may be off their worst levels earlier in the year, leading subcomponents such as hiring and new orders continued to evidence weakness.

Supply is a negative for oil prices

From the supply side of the equation, the OPEC+ nations (Organization of Petroleum Exporting Countries plus major non-OPEC suppliers, such as Mexico and Malaysia) have increased their production levels as part of a withdrawal of cuts in prior years.

More Economic Analysis:

This coming weekend, ministers from the OPEC+ nations are expected to approve an additional 0.548 million barrels per day (bpd) in production, an approximately 2% increase. This will add to fears of potential oversupply in the face of waning demand, which is likely to lead to further oil price declines.

The upcoming meeting may have been the cause of the price gap lower in West Texas Intermediate (WTI) crude oil price to start the week, shown in the chart below.

The chart shows an image of a crude oil (WTI) candle chart, with a solid burgundy line showing global stocks according to the ACWI stock index ETF, with an Ichimoku overlay.

As I suggested in early August, the net balance of effects is oil price negative, and the price charts support that with the price dropping below the key support of the Ichimoku cloud, now resistance at $66.85 in WTI (CL1).

Oil prices and stocks are diverging

TradingView/TheStreet.com/Brian Dolan

Alternatively, the lower price gap could be a ‘blow-off low' for the time being, meaning prices may recover in the short term to better selling levels.

The immediate downside remains in play while below the $63.28 Tenkan line (light blue line, fast moving average); above may see a recovery into the $66 area (and falling) of the Kijun line (red, slower moving average), with the cloud bottom still at 66.85 as major resistance.

For WTI, the big round psychological support at $60 is now within reach and likely becomes a market target objective. Given an RSI reading of around 40, the downside still has more room to run, meaning prices are not yet overextended to the downside.

Why oil prices matter to stock investors

Historically, oil prices and stocks have had a positive relationship, meaning they tend to move in the same direction. However, the positive correlation is relatively minor, at only +0.3 to +0.5 over the long term, according to price data.

Still, according to a recent report by the CME Group, the S&P 500 stock index has been 70% correlated with day-to-day movements in WTI crude oil so far this year. This is the highest correlation over any rolling 30-day period since 2012. The one-year rolling correlation has risen sharply to its highest level since 2013.

Overall, the weakening global demand and weaker energy prices make sense. However, stocks continuing to make new all-time highs does not quite fit that global slower-growth scenario, suggesting something has to give.

Individual stock sectors will be impacted in different ways. For example, if stocks begin to decline overall, the sectors that benefit from lower energy costs may decline relatively less than those with more negative exposure to oil prices.

In particular, look for transportation (JETS) , consumer discretionary (XLY) , industrials (ex-energy) (XLI) and even tech stocks (XLK) as likely beneficiaries of lower energy prices.

The biggest loser is obviously the energy sector (XLE) itself, whose profitability is directly tied to the price of oil. Other losers may be in oilfield services (OIH) , mid-stream/pipeline services (AMLP) and materials (XLB) . Oddly enough, banks (KBWB) may also be on the losing side due to high recent lending to oil-sensitive companies, as default risks rise as oil prices decline.

In short, if oil prices remain under pressure, which seems likely, stock investors should be on the alert for a correction lower in overall stock prices, with a differentiated view based on sector-specific vulnerabilities to lower oil prices.