If oil prices keep falling they could sound the death knell of the stock market rally, now in its ninth year, according to Gary Shilling, president of A. Gary Shilling & Co., an economic research and money management firm.

In that case, “financial worries will no doubt magnify, and the result could be the shock we’ve been looking for that would end the long bull market in stocks that started in March 2009 and precipitate a recession,” writes Shilling in his latest monthly economic research and strategy report.

(Related: Equities Are Overvalued, Many Investors in Merrill Survey Say)

Shilling expects oil prices will eventually fall to $10 to $20 a barrel, which “would be a financial shock reminiscent of the dot-com collapse in the late 1990s that precipitated the 2001 recession. It would also resemble the subprime mortgage debacle in the mid-2000s that touched off the 2007-2009 Great Recession, the deepest since the 1930s.”

(Related: Investor Optimism Stalls: Wells Fargo/Gallup Survey)

But why are lower oil prices bad for stocks? The conventional wisdom has been just the opposite, that lower oil prices support stocks because they put more money into consumers’ pockets to spend on goods and services, which would boost corporate revenues and earnings.

“The relationship between oil and stocks has changed,” Shilling tells ThinkAdvisor. Since 2014, when OPEC declined to cut production, the S&P 500 has tended to rise as oil prices climb and fall when oil prices decline, according to Shilling.


That’s due in part to the declining share of oil stocks in the Standard & Poor’s 500 index, down to 6% from 16% in 2008, says Shilling. “Seven of the 10 worst-performing stocks in the S&P 500 index this year are in the energy sector.”

In addition, investors may be more focused on the negative effects of lower oil prices, namely that the financial problems of highly leveraged energy companies due to lower oil prices could spread beyond that sector, writes Shilling.

Oil prices are currently down almost 17% year to date to around $44 a barrel in the U.S., having recovered slightly from a low that pushed the market down more than 20% into bear market territory.

These lower prices reflect a market that’s out of balance, with supply continuing to exceed demand despite production cuts by OPEC and its allies largely because American frackers continue to increase productivity and output, says Shilling.

He expects they will continue to produce as much oil as they can until prices fall below marginal costs, which are in the $10- to $20-a-barrel range.

At the same time, he expects demand for oil will continue to fall because of increasing use of alternative fuels and increasing spending on services rather than goods as economies, like China, grow, consuming less oil.

“Even OPEC has forecast that global demand for oil will peak around 2030,” says Shilling.

Two announcements this week herald a future with less demand for oil: Volvo announced it would end combustion engines on all new vehicles by 2019, and France announced the end to all oil-fueled vehicles by 2040.

Shilling sees another catalyst besides lower oil prices that could derail the stock market rally: the Federal Reserve. It’s in the process of raising rates and will soon begin to unwind its swelling balance sheet, unloading the Treasuries and mortgage-backed securities it purchased during its quantitative easing program.

Those moves by the Fed can “almost certainly cause a recession,” says Shilling.

Whether it’s the Fed or a sharp oil price decline or both, the stock market rally is vulnerable, according to Shilling. “Stocks are very expensive but you need some kind of trigger,” says Shilling. “It’s kind of a horse race. Which one will get there first? 

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