By Gary Brooks, CFP®
The trapdoor opening on oil prices provides a good example of how randomness is inherent in all investment markets. As much as we would like to think that investments progress in logical patterns and for justifiable reasons, it’s simply not true all the time and there are no signals when trends will change or how sharply.
The price of a barrel of oil was steadfast above $100 for 43 consecutive months through August 2014. By Thanksgiving, a rout was on. Through December, people posted photos of gas price signs on social media, shocked to see the per gallon fare approach $2. While this was good for consumers and transportation companies, it forced the energy sector into an unusual departure for an otherwise robust stock market.
As Nassim Taleb writes in Antifragile, sometimes its complacency and appearance of steadiness that is the impetus for swift market change. “Absence of fluctuations in the market causes hidden risks to accumulate with impunity,” Taleb writes. “The longer one goes without a market trauma, the worse the damage when the commotion occurs. Our minds are in the business of turning history into something smooth and linear, which makes us underestimate randomness. But when we see it, we fear it and overreact.”
Is it an overreaction driving the oil price below $50 per barrel to start 2015? It seems logical that an oil price that sustained the $100 floor for nearly four years could revert to the mean, perhaps not returning to $100 soon, but likely finding some higher equilibrium.
“It’s hard to say what the right price is for a commodity like oil … and thus when the price is too high or too low,” wrote Oaktree Capital’s Howard Marks in a recent memo. “Was it too high at $100-plus, an unsustainable blip? History says no … And if it wasn’t too high then, isn’t it laughably low today? The answer is that you just can’t say.”
Regardless, there won’t be a signal of a change in trend and any forecasts you see about oil price will almost surely be inaccurate, if not wholly wrong. It’s simply a fact of markets that randomness must be expected, if not understood. It’s those market influences that are not well understood or anticipated that drive changes in market direction. Now that oil has everyone’s attention, it likely won’t be what causes the next sharp change in up or down market sentiment. It’s also not likely that interest rate increases, inflation or the value of the dollar will be the source of new problems. All those things are clearly identified on investors’ radar.
“Asset prices are often set to allow for the risks people are aware of,” Marks writes. “It’s the ones they haven’t thought of that can knock the market for a loop.”
This is not to insinuate that preparations should commence for a market correction in 2015. Certainly, the U.S. economy continues to post impressive growth relative to the rest of the developed world. And there are many factors showing positive trends. But it’s also clear that from most measures the U.S. stock market is not inexpensive.