Does the S&P Really Need Higher Oil?
The steady drumbeat of lower and lower Crude Oil prices continues. Oil’s fall from its peak in 2014 is up to an astounding 67%. This is fast approaching the largest decline in history, the 68% drop during the financial crisis of 2008-09.
With the S&P 500 struggling to hit new highs in 2015, much of the blame has been placed on lower Oil prices. If only Oil prices were higher, say the pundits, stocks would be soaring. But how accurate is this story? Do stocks really need higher Oil to perform well?
Let’s take a look back at history.
We have data on Crude Oil (Generic First Futures 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.
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.
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.
Ironically, while the fear of the day is over lower Crude Oil prices, historically the opposite situation has been more harmful for markets and the economy. If we look back at history, 1-year spikes in Crude above 90% occurred in 1987, 1990, 2000, and 2008. All of these spikes were associated with equity Bear Markets and the 1990, 2000, and 2008 spikes associated with U.S. recessions. So perhaps the greater fear should be not a continued slide in Crude but a spike higher.
That is not to say that some stability or a bounce in Crude in 2016 would not be welcomed by U.S. stocks. It most likely would if the rise could be attributed to an increase in global demand. But predicting whether and why Crude rises and falls is not an easy game to play. Harder still is predicting its impact on stocks.
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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 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 three 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 an 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.
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