Why does the stock market keep changing its story?

The company’s stock is up 21% this year, putting it in fourth place behind Nvidia and Meta, and very close to Amazon. Exxon’s new high Friday was driven by an important shift in the market, and it’s a new story that investors would be wise to pay close attention to in case the market changes again.

Exons are at the center of two stories. Strong oil demand due to a stronger-than-expected global economy and supply issues due to wars in Ukraine and the Middle East. Both moves were notable this week, as crude oil prices rose on Friday on solid jobs data, a day after oil prices rose on Thursday on concerns about escalating tensions between Israel and Iran. Oil stocks are winners in both stories, but most of the market prefers one or the other.

Until recently, investors focused on lowering inflation rates as lowering bond yields. This was good for growth stocks, which are already winners thanks to the excitement around artificial intelligence.

Markets have not forgotten about inflation, but they are putting it aside in favor of focusing on a stronger-than-expected economy that will boost oil demand. The S&P 500’s energy sector, of which Exxon is the largest member, has now outperformed the tech sector this year, and on Friday, including dividends, surpassed communications services, which includes Meta and Alphabet.

The energy sector’s valuation, using price-to-earnings ratios, rose to the highest since the Federal Reserve began raising interest rates in March 2022.

Investors like to distill the arcane variables that drive prices into a single story. Once enough people agree on “what moves the market,” the narrative can become self-fulfilling, but of course, until something interrupts the narrative and changes the narrative, oil Like gold, it is in the unusual position of benefiting from two competing themes. Hot economy and geopolitical threats.

It helps to check the recent history of the market. The situation changed significantly in October, when the 10-year Treasury bond hit 5%, and the previously hawkish Fed officials turned dovish, and high bond yields no longer weighed on the economy. That’s when I was worried. Yields fell and stock markets rose, helped by Federal Reserve Chairman Jerome Powell’s “Powell Pivot” to lower interest rates. Investors had priced in six rate cuts this year by early January, and every sign of lower interest rates pushed stocks higher.

In January, the conversation began to turn to the economy. Growth turned out to be stronger than expected, and the Fed emphasized that it expects to cut interest rates only three times. Rather than worrying that interest rates would be higher than expected, investors welcomed the prospect of fewer rate cuts as a sign that the economy is strong. The switch has been completed, from good news about the economy being bad news for stocks to being good news for stocks.

The problem with growth is that there are limits to growth, and central to those limits is the price of oil. Higher demand across the economy causes oil prices to rise and more of consumers’ money to be spent at the pump. Too much demand and higher prices mean other parts of the economy suffer losses.

The same holds true, albeit to a lesser extent, for other products, with manufacturers in the latest S&P Purchasing Managers Survey reporting significant increases in input costs in March, the fastest pace in nearly a year. They report that they have increased their prices.

The danger for investors is that recent gains in inflation-sensitive oil, gasoline, copper and gold (the yellow metal hit new highs on Friday) could cause investors to reverse as economic growth triggers a second round of inflation. This is a signal that they will be forced to do so. I’m worried that prices will rise again.

The strong economy is also pushing the limits of economic growth, which is concentrated in interest rates. The 10-year Treasury yield rose sharply this week, briefly hitting 4.4% on Tuesday due in part to PMI data, but moved closer to that level on Friday following the positive jobs report, but remains below its October peak. This is well below the average of 5%. .

One warning that the story could change again is that Tuesday’s spike in bond yields led equity investors to once again treat rising yields as bad news, pushing stocks lower as borrowing costs rise. Thing. This comes after months in which markets have widely treated rising yields as a sign of stronger growth potential, and therefore good news.

Shamik Dahl, chief economist at BNY Mellon Investment Management, believes the story will change significantly when markets switch from pricing in fewer Fed rate cuts to preparing for actual rate hikes. “Then there’s a big narrative shift. The market likes a relatively simple story of hanging a hat,” he says.

So, does Exxon belong to the tech giants? This is not a tech stock, but Amazon is a retailer, Apple sells music and consumer goods, and Tesla makes cars. The difference is that oil producers don’t just thrive on growth-driven inflation. We also benefit from supply-side issues, which are many. Ukraine’s attacks on Russian oil facilities, Yemen’s aggression in the Red Sea, and the threat of conflict between Israel and Iran all support oil prices, a haven for gold.

Non-energy stocks, especially cheap value plays, should be fine in a phase where growth pushes inflation higher, but not prohibitively so. But oil supply shocks only help oil inventories; the rest suffers from slowing growth, recession, and even stagflation.

It’s too early to know which way the story is headed. My prediction remains that inflation will remain high, central banks will refrain from cutting interest rates, and the economy will eventually slow. For now, oil stocks offer another way to bet on growth and some protection if geopolitics ends the growth story.

Email James Mackintosh at james.mackintosh@wsj.com.