Chart of the Day – Oil and Stocks Correlation

by Enis June 22, 2012 1:49 pm • Commentary

As oil falls, the bull market cheerleaders are starting to use it as part of the bullish thesis again.  As Dan said in his MorningWord today, we are not cheerleaders, just traders trying to make money.  And the evidence says that lower crude oil is not bullish for stocks.

Today’s chart is the correlation of WTI crude oil to the SPX for the past 5 years:

The two assets are almost always positively correlated (moving in the same direction), except for a brief period in 2008 when crude oil had its parabolic spike.  While many pundits like to say that lower oil helps consumer spending, the reality is not quite so simple.

The obvious explanation is that lower oil implies lower global growth, which is bad for stocks in general.  But there is also an important flow of funds argument here.  Many investors globally are direct beneficiaries of higher oil.  In fact, the largest sovereign wealth funds in the world are almost all from countries with substantial fossil fuels.  When crude oil falls, those funds have less cash to invest, and asset markets as a whole likely lose buyers.  The common consumer who benefits from lower oil doesn’t use that extra cash to go buy stocks or bonds or real estate.

In other words, lower crude oil prices take money out of the pockets of the richest consumers globally, and put money into the pockets of the poorer end of the consumer spectrum.  That is one reason why luxury goods makers like TIF, COH, and RL have been following oil lower recently, while WMT and DG have been acting inversely to oil prices.