Over the last few years we have noticed that the shrill tone so common in social media has drifted over to person-to-person email as well. For example, a few weeks ago we highlighted rising Middle East tensions with Iran as a potential geopolitical issue. One reader accused us of watching too much CNN/MSNBC. Another thought we were neo cons of the John Bolton/Dick Cheney school. In reality, all we’re trying to do is help our clients make money.
Case in point: today’s events in the Straits of Hormuz and Gulf of Oman. The US is accusing Iran of attacking two large oil tankers, and West Texas Intermediate crude oil prices are 1.7% higher this afternoon. Granted, crude looked oversold going into this event. Even with today’s bounce WTI, is solidly in bear market territory, down 21% from the April 23rd highs of $66.30.
To our thinking the only macro question that really matters regarding oil prices is “how high is too high?” Where, in other words, do rising crude prices cause a US recession? The institutional memory of capital markets recalls the years 1974, 1979, 2000 and 2008 as if they were yesterday. High oil prices have killed more economic expansions than any central bank policy.
Our answer is that it’s not the price level that matters but the percentage change that impacts US consumers/businesses and the global economy as a whole. The logic here:
- Economies adapt to prevailing oil prices. Businesses and consumers anchor expectations for future prices on wherever recent levels happen to be. As long as the near future resembles the near past, oil prices have little effect on the macro economy.
- Any meaningful price spike above recent history squeezes household and enterprise budgets. For example, the very first oil shock of the modern era (1973) saw oil go from $2/barrel in January to $10/barrel by December. That 400% move is what caused the 1973 – 1975 US recession.
Looking at the historical record back to 1970, our math says it takes a doubling of oil prices over a 12-month period or less to make a US recession inevitable and/or portend stock market concern/volatility. There is a chart below, but here’s a highlight reel of every peak period back to 1970 where oil prices increased by 100% or more (or very close to that) in 12 months.
- March 1974: +525%, from $2.08/barrel in the same month the prior year to $13.00/barrel
- November 1979: +209%, from $13.20/barrel to $40.75/barrel
- August 1987: +104%, from $9.62/barrel to $19.62/barrel
- October 1990: +87%, from $18.42/barrel to $34.50/barrel
- February 2000: +153%, from $10.75/barrel to $27.22/barrel
- June 2008: +93%, from $68.18/barrel to $131.52/barrel
- Note: data from the World Bank, using a blend of global contract prices. Email us if you would like the spreadsheet.
By our math, this simple heuristic – a “double means trouble” – has an 83% hit rate in calling a US recession with no false positive readings. The only miss – August 1987 – was still a useful signal in that it presaged the October stock market crash.
So where do we stand today? A few relevant data points:
- A year ago at this time WTI crude prices were $65/barrel.
- Today’s price is $52/barrel, 20% lower than last year.
- Using our 100% rule, oil prices would have to reach $104/barrel over the next year (or less) to signal recession risk.
Bottom line: it would take a truly dramatic turn of global economic/geopolitical events to lift crude prices over $100/barrel in the next 12 months. “Never say never”, but such a move seems very unlikely. And remember that since 1970 the US has not experienced a recession in the absence of a doubling in oil prices. With all the concerns over a slowing domestic economy in the last few months, that is a comforting sign.