Tuesday, December 16, 2014

What Stock Prices and Oil Prices Don't Have in Common: You Can't Chart Stocks

In September, Myles Udland  wrote an article citing Burton G. Malkiel and his book, A Random Walk Down Wall Street, noting, "The past history of stock prices cannot be used to predict the future in any meaningful way." This is a great point.

I also saw Udland's article from today, which notes oil prices (and stock prices) have gone bonkers. Both prices have fluctuated wildly, and oil has been mostly trending mostly downward. As I have said before, I don't expect prices to stay low (sub-$70 per barrel) for long, but time will tell.  

Low oil and gas prices are certainly having an impact on markets and economies. The big one right now is Russia, which is struggling, in major part because of low oil prices.  The ruble has taken a beating, and the nation's central bank raised interest rates from 10.5 to 17 percent. Wow.  

The bulk of U.S. oil production appears safe well in the low- to mid-$40 per barrel price range, and I don't think it will stay below $55 for long.  Then again, as much as I follow all of this, I am still a law professor, and not a financial analyst, so keep that in mind.  

Anyway, having read all of this, I was reminded that people are sometimes inclined to view stock prices and commodities markets similarly. That would be wrong. Despite my views that oil is likely to go back up, at least some, it's also worth noting that using history as a predictor of markets is a dangerous game.  It's reasonable to assume that, eventually, a market will go up, but whether it will take three weeks, three months, or three years (or more) is hard to say.  

One recent report notes that oil price histories suggest we're near the bottom, and that (on average) prices should rebound significantly. The timing here is unpredictable, too, but the history of oil prices do suggest a rebound will happen sooner rather than later, even with global markets struggling. 

Uland's articles keep the issues separate, but still, lest anyone get confused (and history suggest they might), it is worth noting that charting commodity markets is different than charting stock prices.  As Professor Bainbridge's Safety Tip of the Day: Charting Doesn't Work  from ten years ago notes, "Consistently, empirical studies have demonstrated that securities prices move randomly and, moreover, have shown that charting is not a long term profitable trading strategy." Bainbridge similarly cites Burton G. Malkiel, A Random Walk Down Wall Street  (1996)  in that post, and in an earlier one from 2003, Random stock traders and the ECMH; with a review of Malkiel's Random Walk.  

I learned a lot about stock markets (and Business Organizations) from reading the good professor's writing, and I thought it worthwhile to continue to spread the message: Even though some people like to think that stock prices will follow historical trends and that stocks are like commodities and currencies, you follow their lead at your own peril. 


Corporate Finance, Current Affairs, International Business, Joshua P. Fershee, Law and Economics | Permalink


Did you see this? http://thereformedbroker.com/2014/12/12/theyre-all-making-it-up/ You might enjoy it :-)

Posted by: Ann Lipton | Dec 16, 2014 1:30:22 PM

I'm not sure I understand what you're arguing here. Are you saying that the past pattern of oil prices can be used as a predictor of oil prices although similar data wouldn't work for stocks? Given that the price of a commodity, like that of a stock, reflects all current knowledge, why wouldn't commodity prices follow the random walk? I would assume that current prices depend chiefly on expected supply and anticipated demand. Is the argument that falling oil prices (unlike falling stock prices) are a signal of future production, because they will drive supply down?

I'm not challenging you, I'm just trying to understand the argument that commodities are different.

Posted by: Frank Snyder | Dec 17, 2014 9:43:31 AM

Essentially, yes, you've got my argument, though I admit I could have been clearer on that. Commodity prices are different than stocks because the commodity is used and desired in different ways than individual stocks. Technical analysis is thus useful for commodities in ways it is not for stocks. As the first Udland article notes (and I fixed the link): "Technical analysis, in fact, creates much of the foundation for trading in currencies and commodities. And given that these assets lack the sort of capacity for being analyzed in myriad ways like equities, technical analysis sort of becomes fundamental."

A good description on the differences in commodities and stocks is Gorton and Rouwenhorst, Facts and Fantasies about Commodity Futures :

"Commodity futures are still a relatively unknown asset class, despite being traded in the U.S. for over 100 years and elsewhere for even longer. This may be because commodity futures are strikingly different from stocks, bonds, and other conventional assets. Among
these differences are: (1) commodity futures are derivative securities; they are not claims on long-lived corporations; (2) they are short maturity claims on real assets; (3) unlike
financial assets, many commodities have pronounced seasonality in price levels and volatilities. Another reason that commodity futures are relatively unknown may be more prosaic, namely, there is a paucity of data". (footnotes omitted)

The link from the Ann Lipton's comment is useful here, too: They’re all making it up.

Posted by: Joshua Fershee | Dec 18, 2014 8:27:04 AM

Post a comment