How Oil Prices Affect the Stock Market: What Investors Should Know

Oil is one of the most significant commodities that power the world’s economy. Everything from transportation services to manufacturing requires oil. Other sectors like electricity production and plastics production all run on oil derivatives. Because oil is relied on so heavily by every industry, swings in oil prices can cause fluctuations in financial markets as well.

Investors have likely noticed that when oil prices spike or crash, the stock market seems to react. The stock market can soar. Energy stocks rally. Or the broad market can plunge along with the price of oil. But what does oil have to do with the stock market?

If you’ve ever wondered how oil prices impact the stock market or why oil prices are important to investors, this guide will teach you everything you need to know about oil prices and how to trade them.

Why Do Oil Prices Matter?

Oil prices matter because oil is required to operate the global economy. From transportation services to goods production to shipping and logistics, every industry requires energy to function.

When oil prices change, it affects the bottom lines of nearly every public company on Wall Street.

For example, when oil prices rise:

• It becomes more expensive to transport goods via trucks or ship products overseas.
• Manufacturing companies pay more to produce goods.
• Inflation tends to rise.
• Consumers have less spending money.

When oil prices fall:

• Consumers and businesses have more money to spend
• Inflation goes down.
• Operating expenses decline for transportation-related companies.

Stock markets tend to react to changes in oil prices because oil price swings impact company earnings.

Oil Prices and the Stock Market

Oil prices can move both upwards and downwards for the stock market. Oil prices do not always move the stock market in the same direction. During times of economic growth and expansion, oil prices can go up and the stock market can go up.

However, if oil prices rise too quickly or reach extreme levels, then the oil price increase can actually harm the stock market.

There are three main ways oil prices impact the stock market.

#1 Oil Prices Impact Corporate Earnings

Oil prices impact the bottom line of almost every public company. Companies that use oil to provide services to customers directly feel the pressure of high oil prices.

For example:

• Airlines — Airlines spend millions of dollars on jet fuel every year. When oil prices rise quickly, airlines cut into their profit margins. Therefore, airline stocks tend to drop when oil prices rise.
• Shipping and logistics — The same thing happens with freight trucking companies and shipping companies.
• Retailers with large distribution networks — When oil prices rise rapidly, transportation costs increase. Companies like Walmart, Amazon, and Target must spend more money to get their goods to market.

On the other hand, if oil prices rise, companies that produce oil benefit from higher oil prices.

The more crude oil costs, the more money energy companies stand to earn.

#2 Oil Prices Impact Inflation

Oil prices can impact inflation because energy costs are one of the largest drivers of inflation. When oil prices rise quickly, gas prices typically rise.

If it costs more to fill up at the gas station, consumer prices usually rise as well. As a result, inflation can rise when oil prices soar.

Higher inflation often leads to higher interest rates, which can negatively impact stock prices.

#3 Oil Prices Are Indicator of Economic Growth

Oil prices are often used as a leading indicator of economic growth. When the world economy is strong, we tend to see rising oil prices.

This is because a robust global economy requires more energy. More manufacturing production requires more oil. More transportation activity means higher oil demand.

Therefore, if oil prices are rising, it’s typically a sign that the economy is growing. If the economy is growing, it’s generally a good sign for the stock market.

Which Stock Market Sectors Benefit from Rising Oil Prices?

Energy – Obviously, energy companies benefit from rising oil prices.

Oil and gas exploration companies stand to make more money when oil prices are high. Oil Refining companies can make more money when crude oil sells at higher prices.

Oilfield Services – Companies that provide support services and equipment to oil producers benefit when oil prices rise.

When oil companies start to generate more profits from higher oil prices, they often spend more money on equipment and tools to ramp up production.

If oil prices are rising, commodities often rise with it. So mining companies can benefit from a surge in oil prices.

Which Industries Struggle When Oil Prices Rise?

Airlines – Airlines are one of the most sensitive industries when it comes to oil price movements.

Because jet fuel can make up such a large part of an airline’s operating expenses, when oil prices rise, airline stocks often decline.

Transportation – Increased oil prices can hurt transportation companies’ stock prices.

Companies like FedEx, UPS, and shipping companies can suffer when oil prices rise.

Consumer Discretionary – When oil prices spike, consumers have less money to spend at the store. If it costs more to fill up your car with gas, you likely have less money to spend on other discretionary items.

Companies that fall into the consumer discretionary category can include stocks like Amazon, Netflix, Walmart, shopping malls, and more.

What Happens to the Stock Market When Oil Prices Drop?

But oil prices don’t always move upwards. What happens when oil prices decline? When oil prices fall, it’s typically bullish for the stock market.

This is because it cuts corporate expenses and gives consumers more spending money. However, if oil prices are plummeting because the global economy is starting to contract, then a drop in oil prices can signal troubling times for the stock market.

The largest industry that gets hit the hardest when oil prices plummet is the energy sector.

Examples of How Oil Prices Impact the Stock Market

There have been several occasions where oil prices drastically moved, sending the stock market in different directions.

2008 Oil Price Run-Up

During the summer of 2008, oil prices reached a staggering $147 per barrel. Energy stocks soared during this time period.

But ultra-high gas prices were starting to stifle the global economy. Plus, inflation was starting to become a concern.

Fast forward to October of 2008. The price of oil had crashed and took the stock market with it.

2014 Oil Price Crash

In 2014, oil prices collapsed from over $100 a barrel down to under $50 a barrel. As you can imagine, energy stocks plunged when oil prices crashed.

Yet many sectors in the stock market benefited from lower oil prices. Everything from airlines to retail benefited from a fall in oil prices.

2020 Oil Crash

Just look at what happened in 2020 when the price of oil went negative. Oil prices crashed amid the COVID-19 pandemic.

As a result, the stock market entered into a steep bear market andsent energy stocks into a tailspin. However, the tech sector and growth stocks roared to record highs in 2020.

How to Trade Oil Prices

Investors can use several different strategies to trade oil prices.

Rotate Into Energy Stocks – If you think oil prices are going to rise, consider rotating some of your portfolio into energy stocks.

When you anticipate oil prices to fall, reduce exposure to energy stocks and increase exposure to sectors that benefit from falling oil prices.

React To Inflationary Pressures – Rising oil prices can create inflation. If inflation rises, the Federal Reserve could respond by raising interest rates.

Higher interest rates tend to negatively impact stock prices. Consider trimming stock positions if you believe oil-driven inflation will cause the Fed to raise rates.

Don’t Get Too Leveraged In One Sector -Oil prices are highly volatile and react to many different factors. Just because you think oil prices are going up doesn’t mean you should put all of your money into energy stocks.

Diversification is critical to your long-term investment success.

Factors that Affect Oil Prices

There are a variety of factors that impact oil prices.

Supply and Demand – Whenever anyone talks about what is affecting oil prices, they always mention supply and demand.

Of course, supply and demand is the main driver of oil prices.

Geopolitical Events – Political unrest in the Middle East can cause oil prices to spike. During times of uncertainty, buying oil futures can quickly send oil prices higher.

Production Quantities – Who doesn’t love a little supply and demand manipulation? Whenever the oil cartel OPEC meets, they always discuss increasing or decreasing oil production.

A stronger US dollar can also cause oil prices to fall.

Oil Price Predictions

Predicting oil prices is extremely difficult and nearly impossible to do. Instead of attempting to predict oil prices, investors should focus on how they can impact their stock portfolios when oil prices change.

Should You Trade Oil Prices?

Oil prices are something that investors should pay close attention to but shouldn’t attempt to trade regularly.

Instead, use oil prices as a indicator of how you should position your stock portfolio.

For example, if you think oil prices are going to rise, buy energy stocks and short consumer discretionary stocks.

Bottom Line on Oil Prices

Oil prices have a significant impact on the stock market because they drive inflation and impact nearly every company’s bottom line.

While rising oil prices can send energy stocks soaring, it can crush sectors like airlines, transportation, and consumer discretionary stocks.

If oil prices are crashing, it’s generally a good sign for the stock market. But if oil prices are crashing due to a weakening global economy, it could spell doom for the stock market.

Investors should always pay close attention to oil prices and position their stock portfolios accordingly.

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