Yesterday, the Dow Jones Industrial Average (DJIA) index declined by 0.42%, or 130 points, due to falling oil prices and fears of an upcoming recession. The DJIA index was, in fact, down close to 700 points in early-market trading on July 5 before it regained lost ground. Other major indices such as the S&P 500 and Nasdaq Composite recovered early losses and ended the day in the green.
The U.S. oil benchmark, also known as the West Texas Intermediate crude, touched a low of $97.43 per barrel yesterday and traded under $100 per barrel for the first time since May. Oil prices declined by 8% on July 5 as investors are worried an economic recession will lower demand for gas and related products. Brent crude, the international benchmark, fell by 9.45% to close at $102.77 per barrel.
Expectedly, the Energy Select Sector SPDR Fund lost close to 4% on Tuesday. Additionally, energy heavyweights such as Halliburton, Marathon Oil, and Conoco-Philips fell by 8.1%, 6.3%, and 7%, respectively, in the last trading session.
Will oil prices move lower in the second half of 2022?
The energy sector is highly cyclical and grossly underperforms the broader indices during a downturn. According to investment bank Citi, a global recession can pull back Brent crude prices to $65 per barrel, reducing oil producers’ revenue and profit margins significantly.
In recent months, the reopening of economies and Russia’s invasion of Ukraine have increased oil demand and resulted in supply chain disruptions, pushing Brent crude prices to multi-year highs.
Alternatively, higher commodity prices have resulted in higher inflation rates, spooking the Federal Reserve. As a result, the regulatory body developed a hawkish stance to combat inflation with multiple interest rate hikes. Last month, it raised interest rates by 0.75%, the largest hike since 1994.
The ongoing interest rate hikes in 2022 are expected to reduce the money supply in the economy and stem inflation. However, it will also increase borrowing costs and interest payouts for corporates and individuals. While companies will wrestle with compressed profit margins, individuals will be impacted by higher mortgage payments and other borrowing costs.
Further, interest rate increases also shift capital towards lower-risk asset classes such as bonds, accelerating the sell-off in the stock market.
Another recessionary indicator is the inverted yield curve, where interest rates for short-term treasury bonds are higher than long-term treasury instruments. On Wednesday morning, the 2-year Treasury yield stood at 2.818%, while the 10-year Treasury yield was lower at 2.8%.
Historical data suggests that if the yield curve remains inverted for an extended period, it might lead to a recession.
Why did tech stocks surge yesterday?
Technology stocks have been among the worst performers on the equity markets in 2022. Investors were worried about several macroeconomic factors and the steep valuations surrounding growth stocks resulting in the sell-off. However, stocks such as Zoom Video, Etsy, and MercadoLibre gained 8.9%, 9%, and 8.3%, respectively, on July 5.
The uptick in stock prices can be attributed to the possibility of interest rate declines in case recession fears come true. But right now, the Federal Reserve may be willing to trade an economic recession for lower inflation rates.
Writer at MyWallSt
Aditya took an interest in the stock market during the financial crash of 2008-09. His favorite stocks include Roku and Apple as both companies enjoy a leadership position in their respective verticals and are poised to beat the broader markets consistently going forward.