Oil Prices: Did Their Drop Foresee a Stock Market Tumble?

Oil PricesThere’s been quite a bit of turmoil in global capital markets recently; and it’s evident in the bond market, the U.S. dollar, equities, and oil prices. It’s a very good reminder of how important it is to take stock of the investment risk among your holdings.

For equities, as we know, the market has come a long way since the financial crisis and great recession. And because the monetary stimulus has been so substantial and pervasive, the stock market never really retrenched in the form of a major correction over the last six years. Rather, it produced major price consolidations instead.

Do Oil Prices Forewarn of Stock Market Correction?

No, the dramatic drop in oil prices does not directly predict a stock market crash. But the price drop in what was $100.00 oil for a considerable period of time (knowing that supply was robust) is reminiscent of both the jittery nature of financial markets and the speed in which prices can change.

Currency instability is typically the foremost catalyst for turmoil in capital markets. But the oil price correction we recently experienced was nothing short of spectacular. That price action is a good lesson that all financial assets can be given an instant haircut in very short order.

In the current environment, I believe that investment risk is more important than expected return from stocks. Trading action has been tired all year on the back of two good years of capital gains.

Accordingly, a 20% across-the-board price correction would be reasonable; especially with the expectation that the interest rate cycle is about to change.

If something like this does occur this year, a major price retrenchment in stocks will create much more attractive entry points for new positions.

Where to Find Value in a Market on the Edge

Before the correction in oil prices, valuations in energy were pretty lofty, especially among junior energy producers.

The price correction in this sector created value and I continue to believe that the energy sector is a very worthwhile area for investors to be looking now.

There is value among energy stocks as well as reasonable expectations for growth in what I view as a marketplace willing to slowly bid oil prices higher over the coming quarters.

In the large-cap space, I continue to like Kinder Morgan, Inc. (NYSE/KMI) as a stock to watch on price retrenchments. This stock can be viewed as a special situation among big oil companies.

Transmission and storage of energy products is a great business to be in these days. And the company is likely to shed non-core assets going forward as part of its recent corporate reorganization, thus reducing its capital costs.

I also like ConocoPhillips (NYSE/COP), which is not expensively priced at the moment and offers almost five percent in terms of dividend yield. This is a position to have on your radar now. (See “Oil Price Weakness: 5 Stock Market Picks to Watch for Value.”)

The correction in oil prices is a great reminder about volatility in capital markets and the risk inherent in tradable securities—particularly in stocks.

Even the Federal Reserve admits that there is very little value in the equity market. This is a problem in a slow-growth world.

Accordingly, higher dividend-paying stocks that aren’t expensively priced (like in energy) make for some of the best defensive positions in a market that is overdue for a material price correction.