The price of a barrel of oil reached nearly $150 in early July. Fast forward to today and the barrel price of oil is around $115. This represents a 23% decline in per barrel oil prices in just one month. From my perspective, one does not see price moves of this magnitude unless speculative investing was a part of the recent rise in oil prices. With respect to the dollar, a peak in dollar weakness seemed to be reached in early July when one Euro was equal to 1.59 U.S. Dollars. Over the course of the last month the Dollar has experienced significant strengthening closing at 1.50 dollars per Euro on Friday. Why does all of this matter?
As one evaluates the attractiveness of potential investments, attempting to understand the impact macroeconomic factors such as changes in commodity (oil) prices and currency are important. Unfortunately, the outcomes are not black and white.
As the below chart details, oil and the S&P 500 Index seemed to be highly correlated from early 2007 through August of 2007. However, from late 2007 through July 2008, oil and the S&P 500 Index seemed to have a high negative correlation.
As noted earlier, the dollar has strengthened against the Euro over the course of the past month. As the below chart portrays, a weak dollar (upward sloping red line) and a rising S&P 500 Index seem to go hand in hand. What could be partially at play here is the fact companies in the S&P 500 Index generate a large portion of their earnings (over 40%) from international sources and this has been growing. A weak dollar provides a positive earnings boost to U.S. companies as they convert foreign earnings back into the U.S. Dollar.
Undoubtedly, there are many more factors that will impact stock prices, interest rates, the real estate market, etc.; however, getting a handle on the oil and currency impact to company earnings will go a long way in accurately forecasting future earnings growth. Keep in mind though, some companies have aggressive currency and oil hedges in place in an attempt to mitigate the volatility these price swings have on corporate financial results. Reading company 10-Qs and 10-Ks will provide more insight into some of these factors.
The Dollar-Euro Exchange Rate and U.S. Stocks
CXO Advisory Group
October 17, 2007