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Oil’s Well: Will Higher Oil Fuel Stocks?

Posted On September 30, 2016 11:52 am
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Despite OPEC’s cap production will remain high leaving prices and stocks in a sweet spot.

On Tuesday when word spread the Saudi’s might be falling back in line and reaching an agreement with the rest of OPEC to cap production, the price of oil surged some 4% to a six-week high of $45.80 per barrel. The news also stemmed a stock market slide as the S&P 500 Index quickly reversed morning losses and surged over 1.1% on the day, powered by big gains in energy heavyweights such as ExxonMobil (XOM) and Chevron (CVX).

The question now though, would sustained higher oil prices be good for the stock market? We certainly saw last year, when prices went into a free-fall from $80 per barrel down below $30 per barrel it ended up dragging stocks down with it. It seems the implications of economic global slowdown, potential debt defaults and decline in capital spending outweighed the supposed boost to consumer spending resulting from a “gas tax-rebate.”

So might the opposite be true? That is, would higher oil indicate resurgent economic activity, especially for emerging markets?

Let’s take a look back at history.

We have data on Crude Oil via Bloomberg going back to March 1983. The monthly correlation to the S&P 500 since then? Essentially zero (.05).

Looking at the rolling 1-year correlation, we can see there are times where Oil and equities are positively correlated and other times when they are negatively correlated.

oil-v-sp-9-30-16

During the financial crisis of 2008 and its aftermath, the correlation between equities and Crude became more consistently positive and higher than in prior cycles.

Why? A deflationary, depression-like collapse was the major fear in 2008, and lower Crude prices that year were said to be a harbinger of bad things to come. When that theory did not materialize in 2009, the opposite was said to be true. The rally in Crude was thought to be a positive, indicating reflation and stronger global growth.

This relationship would persist until 2014 when Crude began its most recent collapse. Since then, while equities have struggled to hit new highs, there has been little overall correlation with Oil.

This is more in line with history, as evidenced by the table below displaying calendar year returns in Crude Oil and the S&P. Some thoughts on their unpredictable relationship:

  • From 1984-87, Crude declined every year while the S&P advanced.
  • The S&P continued to advance in 1988 and 1989 while Crude rebounded.
  • Then, in 1990, the S&P experienced its only down year in the 1982-99 period while Crude Oil was up 30%.
  • From 1994-96 the S&P and Crude moved up together.
  • From 1997-98, Crude declined while the S&P experienced two strong years.
  • The 2000-02 Bear Market in stocks displayed no obvious correlation to Crude.
  • From 2003-07, Crude and the S&P rose together during the commodities boom.
  • In the 2008 deflationary collapse, they declined together and during the 2009-11 reflation they rose together.
  • In the past two years, as Crude has suffered one of its worst declines in history, the S&P is higher.

oil-table-image-9-30-16

So do U.S. stocks really need higher Oil prices to generate a positive return?

The answer based on the historical evidence is clearly no. Why? Because it is not clear exactly what a higher or low Crude price means for the overall economy and an S&P 500 Index where the Energy sector which comprises less than 10%.

Most studies show that the U.S. economy (and U.S. consumer), as a net consumer of commodities, ultimately benefits from lower Oil and Gas prices. Similarly, companies outside of the Energy spectrum benefit from lower input costs.

Ultimately, the correlation between Crude and stocks depends on why Crude is moving higher and lower, which is difficult to ascertain in the moment. It only becomes clear in hindsight. Certainly a crash in Crude as we saw in 2008 which was an indication of a collapse in global demand was not going to be a positive for the U.S. equity market. However, a crash in Crude due to increasing supply and alternative forms of Energy could very well be construed as positive for markets. Is that the case today? Again, we’ll only know in hindsight.

And keep in mind that despite the supposed Opec deal oil will keep pumping at a historically high rate.

opec-cap-image-9-28-16

So right here at $45 per barrel oil’s well with the stock world and should continue to be.

About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.