The recent 10% decline in crude oil after the QE3 announcement caught everyone’s attention with the speed of the decline. Though stocks have pulled back, they are still near the highs of the year, while crude oil is around the midpoint of its 3 year range. Given that, I thought correlation between oil and the S&P 500 index might be lower than it has been over the 3.5 year bull market.
In fact, I was mistaken. Here is the chart of the front month WTI contract (black) vs. the SPX index (orange) over the last 3 years, and the correlation between the 2 assets plotted on the bottom half of the graph:
Though the SPX has massively diverged from oil since May 2012, the correlation is actually near 3 year highs. Crude oil has essentially rallied less than stocks on the risk-on days, and fallen more than stocks on the risk-off days, but the phenomenon of trading in the same direction on most days (hence the terms risk-on / risk-off) has remained in tact.
The only significant crop in correlation between the two assets was during the onset of the Arab spring, particularly when Libyan oil output was cut off. The correlation has been above 0.5 for most of the last year. For comparison, I looked at XLE vs. front month oil, and the correlation graph was very similar to that of the graph above, but shifted about 0.1 higher.
Bottom line, in this market, assets are still moving in the same direction on a day-to-day basis. But most of the divergences are built up over time due to the magnitude difference of those daily moves.