Oil’s Big Rise Could be Precursor to a Fall in Small Caps

Last week, brent crude price crossed $90 per barrel and touched a high of $105.8 before closing at $94.5.

This may not be a good sign for small-cap investors. Historical data (since the start of 2004) crossed a certain level, there have been sustained corrections in small-cap indices. The corrections are even steeper when the indices were at higher levels.

The best periods for small-cap investors have been when oil prices started rising after correcting significant. However, above a certain level, high oil prices create an inflationary pressure which impact growth. The periods of oil corrections also create short-term panics due to deflationary pressures and money being pulled out of equity markets, especially from emerging markets.

As seen in the chart, in 2007 brent crossed $90, after which the small-cap index could not sustain at higher levels and witnessed a sharp correction. A similar trend was seen in 2011 and 2017-18.

Over the past few weeks, the trends has re-emerged. The CNX SmallCap index has corrected sharply from the peak and crude prices have risen, thanks to geopolitical tensions.

Investors should be cautions now as the market trend may have reversed – from a ‘buy on dips’ market to a sell on bounce’.

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