Stocks Surge 2% Friday But Why Are They So Volatile Lately?
"A surge in oil prices helped put investors in a buying mood early on," the Associated Press reported Friday evening.
The chart above shows the relationship between crude oil and stock prices for the last two months. What happened to the black line from June 2014 to the end of 2015, as the brown line, representing the price of a barrel of West Texas Intermediate crude, collapsed from $107 to $44? Stocks soared!
Any rational person would conclude that when oil prices drop, stocks appreciate. However, look at what happened in recent months. Something has changed in the way oil prices have affected the stock market lately.
In late June 2015, oil prices started another swift descent, tumbling from $60 to less than $40 a barrel in six weeks. On August 24, 2015, the stock market experienced a "flash crash" and a long-awaited correction of about 11% occurred in a day. Since then, the stock market has declined as oil prices dipped lower.
While lower oil prices always have been thought to stimulate the economy - by freeing consumers to go out to eat more and buy more stuff instead of spending on gasoline - the stock market is behaving exactly the opposite way: Higher oil prices Friday was the major reason cited for causing the 2% gain in stocks .
Why is the stock market reacting so illogically? Why is there so much more volatility in stock prices?
The p-e ratio tells you how much investors are willing to pay for $1 of earnings. Look at how the period around the tech bubble, at the turn of the millennium, investors were willing to pay nearly $30 a share for every dollar of profit earned by a company in the S&P 500. Such extremes in stock valuations are signs of irrational exuberance.
Looking at the valuations placed on stocks over the entire 25-year period, from 1990 through the end of 2015, shows that investors have been willing to pay about $17 for every $1 earned by a company in the S&P 500. That market multiple of 17 is the average valuation placed on stocks by investors in a low-inflation environment, like we are currently experiencing.
Now, look at the period highlighted by the dotted circle. Investors went from market multiple of 12 in the third quarter of 2011 to 18 in the fourth quarter of 2014.
Currently, the market p-e ratio is about 16. While it's below the "normal" market multiple of 17, the higher valuation level makes the stock market more susceptible to emotional or even irrational drops.
In the context of this huge long-term bull market and stocks recovering to a more normal valuation level, it make sense for stocks to pause. Although no one can predict stock performance, it is reasonable to expect sideways motion with continued volatility from stocks for now.
- Poo-Poohed By Politicians And Pundits, The U.S. Economy Is Booming
- The No 1. Fake News Story Of The Year Affecting Your Wealth
- News Affecting Your Wealth Dominated The Headlines This Past Week
- U.S. GDP Growth Surprise Propels Stocks To New Record
- Why Does The S&P 500 Keep Breaking Records?
- U.S. Stocks Nearly Doubled In The Last Five Years
- The Big Economic News The Media Keeps Missing
- Trump Tax Plan Upends Year-End Tax Planning
- Key Senators Agree On A Road To Cutting Taxes This Year
- Year-End Tax Planning Could End With A Thrill This Year
- This Week's News About Wealth Management
- The Good News The Financial Press Keeps Missing
- Despite A Chorus Of Bears, The Bulls Played On
- Stocks Dropped For Second Straight Week Amid Strengthening Economic Reports
- Despite Wall Street Guru's Terrible Advice A Year Ago, He's Back
- With Stocks Near All-Time High, Personal Income And Employment Data Are Released
- How Strategic Asset Allocation And Rebalancing Worked In The 12 Months Ended June 30
- Wall Street's "Top" Strategists' Recommendations Are Like Monkeys Throwing Darts
- Stocks Break Another All-Time High. What Is Going On?
- Stronger Than Expected Jobs Creation But CNBC Reports "Trouble Lurked"
- S&P 500 Returned 2.9% In 2nd Quarter And 9.2% In First Half Of 2017
- Despite Distractions, Demographics Are Poised To Drive U.S. Long-Term Growth
- The Federal Reserve's Historic Economic Experiment Entered A New Phase
- Barron's Cover And The Wall Street Journal Reported Alternative Facts