Tahoe-Truckee Market Beat: The correlation between crude oil and stocks
February 29, 2016
TRUCKEE, Calif. — One thing you may have noticed about the stock market this year is that it has been following the price of crude oil. If crude oil is down, there's a good chance the market will decline, too.
According to a recent article in Market Watch, the price of stocks and crude oil has closed in the same direction on 44 out of 60 trading days. That is a pretty high correlation.
There's an old saying that correlation doesn't imply causation. Another one is that correlation begets correlation. There are some reasons that stocks and crude are so highly correlated this year.
One reason is that people who design trading algorithms use correlations like this in their programming and it contributes to the prices moving in tandem.
Another reason is that many countries that depend on crude oil exports end up selling off some of their sovereign funds when oil drops to maintain cash flow. These sovereign funds have investments in US stocks, so they sell stocks when oil declines.
The low price of oil also affects the profits of our energy sector which makes US energy stocks drop. Energy has been the worst performing sector in the S&P 500 over the last year and has been a real drag on S&P earnings growth.
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While the low price of oil has been a drag on the market, there are also a lot of benefits to affordable energy. It has been said that every penny saved at the pump per gallon of gasoline frees up about $1 billion per year to be spent elsewhere. It helps the consumer and our economy is consumer driven. It lowers the costs of delivering goods.
The "peak oil theory" stated that we would hit our peak oil production in about 1970 and after that peak was reached, supplies would decline, prices would rise and the cost of energy would become a real drag on the economy.
Changes in drilling technology proved the peak oil theory wrong. Today we have enough oil right here in the US that we are no longer dependent on oil imports. We also have natural gas supplies that should last at least two hundred years.
Hopefully, the oil price will stabilize and the stock market will disconnect from following crude so closely. It is nice to know that we have adequate energy supplies as we transition into the alternative energy sources of the future.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.
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