Investing.com — Recent developments in the financial markets indicate that the long-standing relationship between stocks and oil prices has unraveled, and this divergence is expected to continue for the foreseeable future.
Traditionally, these two asset classes move together, often reflecting changes in global demand.
However, Capital Economics analysts believe that we are now entering a period where they will follow separate paths.
In recent years, the trends in oil and equities have clearly diverged. While the price has recently fallen to the lowest level in almost three years – below $70 per barrel – the stock market, especially in the US, has seen only a modest decline.
For example, stock markets are down just 3% from their July peak, showing how disconnected these markets have become. The reason for this disconnect lies in the different forces that shape each market.
One of the main reasons behind the difference is the influence of supply-side factors on the oil market. Unlike stocks, which are more sensitive to economic fundamentals and investor sentiment, oil prices are heavily influenced by idiosyncratic supply issues.
OPEC+’s decisions to extend production cuts, combined with a geopolitical risk premium, have disrupted supply dynamics in the oil market.
These supply factors, rather than changes in demand, have kept oil prices under pressure despite changing global economic conditions.
At the same time, stock markets, especially in the US, were driven by very different factors. Enthusiasm about advances in artificial intelligence (AI) has brought a wave of optimism to the stock market, especially among technology indices.
Until mid-2024, this AI-driven optimism helped propel stock markets to new highs, with investors banking on the transformative potential of AI technologies.
While concerns about the US economy have temporarily dampened this enthusiasm in recent months, “we believe there is still room for a revival of the AI-powered stock bubble and this will boost US and global equities in the coming quarters,” the analysts said.
Another aspect of this difference stems from the contrasting performance of China and the US in the global economy. China, a key driver of global oil demand, has seen its economic growth falter, with crude oil imports falling year on year.
This slowdown has weighed heavily on oil prices, exacerbating the decline in global demand. However, this has not had a significant impact on global stock markets, which are more influenced by the performance of the US and other advanced economies, where demand remains relatively stable.
“The US and other major advanced economies will avoid a recession this year and next year our view of the global economy is quite optimistic. We believe this will provide a positive environment for equities to perform well despite weak oil demand,” the analysts said.
Looking ahead, the outlook for oil prices remains weak. With demand from China expected to remain subdued and OPEC+ likely to keep tight control on production, oil prices are likely to remain under pressure for some time to come.
However, this continued weakness in the oil sector is not expected to spill over into equity markets.
The divergence between these two asset classes, which has already become apparent in recent years, is likely to persist as equities remain supported by the performance of advanced economies and the ongoing technological revolution.
Stocks, on the other hand, have a promising outlook. While there are some concerns about the US economic outlook, Capital Economics expects a revival of optimism around AI, which could lead to further gains in the stock market.
While there are risks – such as the possibility of antitrust actions against big tech companies or geopolitical tensions – the base case remains positive.
The technology sector in particular is expected to play a key role in driving the stock markets higher, with AI acting as a key catalyst for growth.
