Stock Investors Should Be Careful After OPEC+ Cuts

To put it mildly, traders are pretty optimistic right now. The S&P 500 has rallied again over the last couple of weeks, with the broad index closing out last week, and thus the first quarter of 2023, 6.6% above the opening level from January 3. That is in the face of continued rate hikes from the Fed, so this seems to suggest that the market believes that, for whatever reason, those hikes are coming to an end soon and will be reversed by year’s end. With a slowing in the rate of inflation over the last few months, albeit a very slight one, I suppose that is at least a view that can be supported logically, even though the Fed themselves don’t seem to subscribe to it.

However, there was always a hint of probably unjustified optimism about it, and that looks even more so this morning than it did before. Traders woke to the news that an unofficial cartel within OPEC+, led by Saudi Arabia, have decided to cut their oil output. A rational market, seeing that and the resulting spike in oil prices, would be trading significantly lower in the premarket. What we have, however, is this in Dow futures:

Let me reiterate what is going on here. The single most influential commodity in terms of inflationary pressure is spiking and looks set to reverse a long-standing downward trend and to keep moving higher for a while, with many analysts talking again about $100 per barrel oil. I know that the Fed looks primarily at core numbers which strip out food and energy, so there is no direct correlation between oil prices and “inflation” as measured by the Fed, but higher oil prices eventually impact the price of everything that consumes energy in the production process or is transported, so pretty much everything made, grown, or processed by mankind.

Meanwhile, stocks, which have gained on a belief that the Fed is winning the fight against inflation, are trading higher in the premarket.

I know that simplistic thinking is out of style right now, but that makes no sense to me whatsoever. The only explanation for it is that it is what Alan Greenspan famously referred to as “irrational exuberance.” That was how he characterized it when traders ignored any inconvenient facts that challenge their preconceptions during the dotcom boom and, lest you haven’t heard, that didn’t end well.

However, that doesn’t mean that selling now is necessarily a good idea.

What people tend to forget is that Greenspan’s remarks came well before the exuberance ended. After he first used the phrase in a TV interview in December of 1996, the Nasdaq gained another 240% before it eventually topped out early in 2000. As traders are fond of saying, the market can stay illogical a lot longer than you can stay solvent. In fact, if anything, the more visceral and less logical a move is, the more powerful it often turns out to be. If you ignore all bad news, you can always find some good, and that will propel stocks higher, no matter what.

Until now, the optimism that we have seen so far this year at least looked like a logical, if debatable conclusion based on an assessment of the available evidence around inflation. However, with stocks trading flat or even higher in the face of what is objectively bad news, we seem to have crossed over into irrational exuberance territory, and while that can continue for some time, at some point reality will intrude and another big drop will come.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.