Asset prices across sectors must reflect the same reality
Einstein’s Relativity Theory posits that the laws of nature are invariant with respect to one’s frame of reference – i.e., independent of the observer’s motion. Similarly, the laws of supply and demand apply equally across all markets. Thus excess supply or demand in one market impacts all markets –changing their relative prices. Over the course of this year collapsing oil prices have been reflected in the relative weakness of energy (e.g., Exxon and Chevron) and Basic Materials (e.g., DuPont and Alcoa) stocks in contrast to strengthening Consumer Discretionary (e.g., Target and Home Depot) stocks.(See our previous feature - Oil Magic). But are they reflecting the same overall reality?
The collapse of the energy sector has a dislocational impact on financial markets generally much like the earlier tech and housing sector busts. Thus the current divergences in relative prices across sectors may in part be masking the greater overall risk endangering all market sectors. (See our previous feature – Mispricing Risk?).
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