How Oil Prices Affect Stock Market

Fuel prices can not only increase the price at the pump, but also increases the prices for food, electronics and other goods. These costs are passed on to consumers who are then reflected in the mood of stock markets. High oil prices make it difficult for businesses to compete globally and also have a robust economy where businesses have less discretionary income to invest.

A Brief History

The Oil Crisis, which began in October 1973, was the cause of the worst stock market crash since the Great Depression. Other factors such as the UK also suffered a bear run throughout the same period, but this is less notable.

The last of the contracts for futures trading on crude oil turned to a negative sign in April 2020. The situation occurred because of the high supply, leading to low demand. Due to the virus, which keeps consumers from purchasing these derivatives, it’s been impossible to mitigate production rates and get demand up again.

Despite a benchmark drop in oil prices, NASDAQ only decreased by sixteen points that week. It then continued to decrease in April but bounced back in mid-May.

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Effect on Stock Market

Although there are a few instances where heavy fluctuations in oil prices were accompanied by stock market swings, recent studies suggest that it is hard to prove that oil prices have an effect on the stock market.

The NASDAQ, NIFTY 50 and BSE SENSEX are not affected by fluctuations in the oil prices because these indices do not hold companies with major stakes in the price of oil.

How Oil Prices Affect Stock Market

Some companies may be negatively affected by changes in oil prices. There are also a few reasons why this may happen.

Increase in Input Costs:
When crude oil prices spike, input costs rise. This means that the overall production costs of that company also rise. In addition to reducing profit margins, this affects other companies who use the same product as an input. For example, aviation companies are impacted by spikes in oil prices because they use it as fuel.

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Increase in Transport Costs:
As the price of crude oil increases, the cost of transport will go up. This will cause higher costs for the company and decrease their profit margins. Furthermore, as the price of oil decreases, stock prices will increase.

Current Account Deficit:

A $10 increase in the cost of oil leads to the current account deficit increasing by 0.55%. This is because a large percentage of imports are due to oil making up India’s total imports. Whenever the current account deficit goes up, more foreign exchange flows out of the country and this can cause the rupee to depreciate. As imports get more expensive, input costs increase and stock prices will fall again. Conversely, if prices for oil go down, imports will be less expensive and stocks will rise again.

Increase in Inflation:
There is a tangible correlation between oil prices and stock prices. When oil prices go up, the inflation goes up and investors get less confident putting their money into firms which then have lower stock prices. However, when the oil price falls, investors become more confident, putting more money into stocks which boosts their prices.

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Takeaway

If a company is heavily dependent on oil, investments in the company may be temporary. Take note of oil prices because their fluctuations could lead to violent fluctuations in price for such companies.

You can check crude oil prices here

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