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Crude Oil, King Dollar, and Explaining Noise

Crude Oil is at its highest level since last July. Meanwhile, the U.S. Dollar Index is not far from its lowest level since early 2015. Looking at the chart below, they seem to be polar opposites in recent years.

dollarcrude1

The monthly correlation between Crude Oil and the Dollar Index (going back to 1983) is -.21, supporting the visualization. Most of the time they do move in opposite directions.

dollarcrude2

But most of the time is not anything close to always.

Historical calendar year returns show that in 47% of years they actually moved in the same direction. One of those years was 1999 when Crude had a record advance of 112%. What did the Dollar do that year? It was up 8%. A year earlier, in 1998, Crude fell 32% while the Dollar fell 5.5%. It would be incorrect, then, to say that Crude is simply the inverse of the Dollar. There is more to the story here.

dollarcrude3

Additionally, when Crude and the Dollar are moving in opposite directions as is more often the case (53% of years), the moves are far from proportional. Crude Oil has an annualized volatility of 33% versus 9% for the Dollar Index. When Crude moves, it tends to be far more extreme than what would be implied by the currency movement alone (example: Dollar index was down 4% in 2009 while Crude rose 78%).

The Need to Explain the Noise

But you often hear in the financial media that Crude is up or down x% “because of” a falling/rising Dollar. Yes, the financial media feels the need to explain every movement, regardless of whether it is actually the reason or just noise.  The reality: there are many factors impacting the price of Crude on any given day, month, or year. The Dollar may be part of that equation but it is not the entire equation. One could also say that the price of Crude is impacting the Dollar, in which case the argument may in fact be somewhat circular.

As it pertains to the U.S. equity market, what is most surprising to many investors is that neither the price of Crude nor the value of the Dollar have had any correlation with the S&P 500 over time (see here and here). You simply cannot predict what the U.S. stock market is going to do based on these two factors.

This may come as a surprise because so much time is wasted on forecasting and fretting about the future direction of Crude and the Dollar and its impact on stocks/economy. The truth: even if you could predict such things with some accuracy, it would not tell you what the stock market or the economy is going to do. The next time you feel the urge to make wholesale portfolio changes based on fears of falling/rising Crude or a falling/rising Dollar, take a deep breath and sit on your hands.

For our research on commodities (Lumber and Gold), click here.

Related Posts:

Does the S&P really need higher oil?

Should equity investors fear King Dollar?

Do stocks need a bull market in commodities?

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

CHARLIE BILELLO, CMT

Charlie-Bilello

Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of four award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors previously held positions as a Credit, Equity and Hedge Fund Analyst at billion dollar alternative investment firms.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.

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