Oil Falls Over 5%

The main reason why the stock market fell Wednesday was because of a 5.38% decline in WTI oil. My prediction for oil prices to fall is because of a high amount levered long trades and high inventory levels finally began to come true. My thesis has been that oil prices falling to the high $30s would hurt energy firms’ profits. Since energy earnings are expected to grow the fastest out of any sector, by far, if growth misses expectations significantly, aggregate S&P 500 earnings will fall. This will cause the stock market’s multiple to shrink less than expected; the multiple is very high making the market in a need of accelerated earnings growth to sustain itself. Regulatory cuts brought about by the Trump administration cannot save energy companies from falling crude prices.

Before I get into discussing oil prices, I will show you one other thing which isn’t sustaining itself. Global credit impulses are falling on a year over year basis because Chinese banks can’t sustain the pace of credit creation they have been on. Without Chinese credit creation, the global economy must rely on productivity and population growth to improve its GDP. The largest credit expansion as a percent of global GDP in, at least, the past 24 years has ended. This does have some relation to oil prices since tightening credit conditions could cause China’s demand for oil to fall.

As I said, oil prices fell over 5% on Wednesday. This crash was the largest percentage drop since February 2016. With energy traders all piling into long positions, the only thing needed to spark a crash was a catalyst. The catalyst was the U.S. Energy Information Administration’s report which showed oil stockpiles increasing by 8.2 million barrels to a record high. The increase was over 4 times the increase expected by analysts. As you can see from the chart below, the spread between oil inventories and the 5-year average is elevated. The last time inventories rose, there was a major price correction. Even though prices fell which caused production to slow, the inventory levels never got back what they were at in 2013.