MorningWord 8/30/13: A Crude Resemblance $USO

by Dan August 30, 2013 9:09 am • Commentary

MorningWord 8/30/13: As the global community contemplates airstrikes against Syria on what appears to be fairly clear evidence that the ruling regime used chemical weapons on civilians, Crude oil has seen a bit of a spike due to potential supply disruptions resulting from instability in the region. Last night we had Ed Yardeni, of Yardeni Research on CNBC’s Fast Money to discuss the very topic, and he made the similar point to us that he made on his blog (via Business Insider) this morning about the effects of oil prices and the stock market:

In the past, more often than not, the S&P 500 was positively correlated with the price of Brent. That’s because the price of oil is highly correlated with other industrial commodity prices. When the price of oil is rising along with other commodity prices, the global economy is growing at a healthy pace. That’s bullish for stocks.

This year, industrial commodity prices have been relatively weak. In this environment, rising oil prices aren’t necessarily bullish for stocks. On the contrary, they can be bearish if they spike up as a result of a geopolitical supply shock. This explains why the S&P 500 Energy sector has been a laggard this year, even though oil prices have been mostly rising since May 1.

In the Chart below, Ed shows the correlation, since the lows in 2009, between the S&P500 and the Brent Crude, which speaks to an economic recovery over that time period, regardless of the catalysts (natural or not).

S&P500 vs Brent Crude since 2009 from Yardeni Research
S&P500 vs Brent Crude since 2009 from Yardeni Research

So here is the thing. Supply shock or not most of the recent economic data here in the U.S., and what we got of earnings guidance by U.S. corporations (despite yesterday’s upward revision to Q2 GDP), do not speak to a robust consumer that could absorb high oil prices or corporations whose profits could deal with increasing input costs.

As I look at crude at about $108 a barrel, it is hard to make the case, after the late June break out that resulted in a nearly 10% rally, that there is too much of a “Syria” premium built in at the moment.

Crude Nymex Futures contract 1 yr chart from Bloomberg
Crude Nymex Futures contract 1 yr chart from Bloomberg

To Yardeni’s earlier point, Crude saw most of its gains this year in January and in July when the economic outlook was a bit rosier than it is now, and June in particular was likely the result of the Fed’s optimism about their ability to pull back from QE due to what they deemed to be at the time an improving economy.

One thing seems fairly certain as we head into the fall. Volatility among risk assets appears to be priced fairly cheap when you consider how emerging market currencies and equity markets are moving, the the recent spike in yields in the U.S. with the backdrop of a weakening U.S. recovery, a looming budget stalemate in Washington and the potential for an unpopular geopolitical situation.  Oh and I forgot the all important 2 day FOMC meeting that starts on Sept 17th.

IN case you missed it in Enis’ MacroWrap, he highlighted next weeks data:

There are numerous economic releases following the Labor Day holiday.  The big ones:

  • ISM Manufacturing on Sept 3rd
  • ADP Employment Change on Sept 5th
  • ISM Non-Manufacturing on Sept 5th
  • Non-farm Payrolls on Sept 6th

Payrolls on Friday will be the most closely watched release.  But the market’s reaction into and out of these data points will be a good indication as to whether the market starts to form a consensus about the policy decision later in the month.  We expect September to usher in a more volatile period than what we have seen for most of the past 2 months.