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Dimitry Smirnov
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Price Of Oil Versus The Stock Market

Apr. 30, 2012 1:31 PM ET
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Includes: APC, CVX, XOM

Before 1998: Crude was extremely cheap due to relatively small global
demand (virtually entirely from developed nations) and relatively plentiful
discoveries. I like to compare this view to the present situation with
ample natural gas stocks (large supply) and the weather being
abnormally warm (low demand). There was actually a
significant negative correlation between the crude oil price movement and
the stock market.

1998~2008: Accelerating economic growth by the developing nations,

coupled with more expensive drilling and fewer oil discoveries led to oil
generally mirroring stock market movement. However, and this is key, oil
prices lagged the stock market. For example, if we blow up the area in
gray of the chart above, we see that when the S&P500 peaked between
2000 and 2001, oil prices only peaked one to three months later.
Since 2008: Since the speculation-induced crash in late 2008, oil prices
have moved in remarkable unison with the stock market. Perhaps even
more remarkable is that the movement has been in sync, and not with oil
prices lagging, as in the 1998-2008 period. I present two different
explanations for the tighter relationship between crude oil and the stock
market. First, we assume the price of oil is "correct," implying an
equilibrium between upward pressure from enhanced global demand and
downward pressure from the increasing financial burden higher oil prices
impose on the average company.Second, we assume that the price of oil
is not correct, and the tight relationship is merely a demand for risk,
regardless of the underlying instrument. Relatively recent comments by
Exxon's Rex Tillerson stating that oil is overpriced suggest that the second
argument is more likely. It remains to be seen whether there are ceilings
in crude oil price that mark a potent ba to economic productivity. An
economics textbook would have you believe so.
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Lawrence Fuller • Jan. 13, 2016 6:20 PM ET
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Price Of Oil Versus The Stock Market

Apr. 30, 2012 1:31 PM ET

Includes: APC, CVX, XOM

Thus, the short answer to question (1) is that the footprint of oil on
economic activity has changed dramatically over time. Initially, with oil
cheap and plentiful, a barrel of oil was an enormous leverage in nearly
any business. Think big: how about the jump from horse transportation to
cars. However, it is clear that this has slowly evolved to a more intimate
relationship where at current levels, the price of oil is likely to be a
substantial obstacle to our future growth.

A quick recap:

Oil prices versus the S&P500

1987-1998 1998-2008 2008-now

Correlation -0.22 0.55 0.86

Relationship out of phase S&P leads by 3 months in sync

Click to enlarge

Keep in mind the relatively low correlations before 2008 are still strongly
significant. Given the myriad of factors affecting stock price movement,
we can expect correlations anywhere close to 1. It is also possible that
after several more years, the post-2008 correlation will drop off. In my
opinion, as long as movement is in unison, this will not degrade the main
conclusion.

Question 2: Crude Oil Prices versus the Oil Sector

Now switching topics a bit, I wanted to investigate whether oil company

stocks respond differently to oil prices than the general market. I
arbitrarily chose to look at Exxon Mobil , Chevron (NYSE:CVX) and
Anadarko Petroleum (NYSE:APC), mainly because they have been around
for so long. Below I show the price movement of all the indices under
consideration, the three oil stocks, the S&P500 and crude oil.

It turns out that two big generalizations can be made from looking at this
data, one on long scales, one on short scales. On longer scales, as seen in
the chart below, oil company stocks follow the price of oil much more
closely the the S&P500. Note the near complete absence of a high in the
oil stocks around 2000, even though the S&P500 had a notable high.
Given the fact that the oil stocks prices are a function of crude oil and risk
appetite, plus the fact that they all pay out generous dividends, from an
economics perspective, these are extremely low-risk, high-reward
investments. (The only problem is the environmentalist in me will not give
oil companies a single penny more than I have to, despite all the tree-
hugging crap they try to promote through their PR campaigns. The
invisible external costs they inflict on the environment are way to high.)

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4. The One Key Indicator That Will Determine Market Direction by Bret Jensen

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How Low Can Oil And The Markets Go?

Bret Jensen • Jan. 14, 2016 7:43 PM ET

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DIVIDENDS & INCOME

1. There's Cheap And There's Dirt Cheap by Brad Thomas
2. Confessions Of A Retired Energy MLP Investor by George Schneider
3. How Can You Avoid Value Traps In This Market?by Chuck Carnevale
4. My 30 Stocks For 30 Years: Q1 2016 Buys by Integrator

ETFS & PORTFOLIO STRATEGY

1. Asset Class Weekly: High Yield Blood Bath by Eric Parnell, CFA
2. Why A Long/Short Portfolio Makes Sense Today- Part II by William Koldus, CFA, CAIA
3. The Great Debate by Loic LeMener, CFA
4. Sequoia Fund Lawsuit: Know What You Own by Reuben Gregg Brewer

MACRO VIEW
1. When The Stock Market Bounces, Rallies Should Be Sold by William Koldus, CFA, CAIA
2. Bank Of America Is #1... by Chris DeMuth Jr.
3. Effects Of The Coming Market Crash On The Economy - And Perhaps On You by
Larry Kummer
4. The One Key Indicator That Will Determine Market Direction by Bret Jensen

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Dimitry Smirnov
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rice Of Oil Versus The Stock Market

Apr. 30, 2012 1:31 PM ET

Includes: APC, CVX, XOM

The second finding I wanted to show was quite a surprise to me, and is
shown below. Unlike the charts above, which are monthly averages, the
graph below compares the correlation between daily crude oil price
movement (in %) and daily change (also in %) of Exxon Mobil's stock
price. The use of XOM is not important; CVX and APC give the same
result. I have tested this correlation when either oil or XOM lead the other
by the number of days shown on the x-axis. First, the boring finding: for
any forecast over 1 day, XOM and oil prices are uncorrelated. Keep in
mind, these are daily prices with lots of noise. Hence, the results I have
explained from part 1 will not be seen until we start averaging over weeks
and months. However, note that during the same day, XOM and oil prices
are certainly correlated. Now the real surprise: if we separate the data
into 4-5 year periods, we see that there has gradually been a rather
substantial increase in this relationship. In fact, compared with the 1987-
1991 period, the past few years have seen a 5X increase in the
correlation. I still don't have a good explanation for this, but it certainly
suggests that investor behavior has dramatically changed.
To summarize, I think two main things are worth noting. The way that
crude oil impacts the markets has changed. It has increased in
importance and will provide a constant check on the speed of economy.
However, the way investors assess crude oil's importance has also
changed, where now it is rather closely associated with most oil
companies' stock movement.

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
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1. There's Cheap And There's Dirt Cheap by Brad Thomas
2. Confessions Of A Retired Energy MLP Investor by George Schneider
3. How Can You Avoid Value Traps In This Market?by Chuck Carnevale
4. My 30 Stocks For 30 Years: Q1 2016 Buys by Integrator

ETFS & PORTFOLIO STRATEGY

1. Asset Class Weekly: High Yield Blood Bath by Eric Parnell, CFA
2. Why A Long/Short Portfolio Makes Sense Today- Part II by William Koldus, CFA, CAIA
3. The Great Debate by Loic LeMener, CFA
4. Sequoia Fund Lawsuit: Know What You Own by Reuben Gregg Brewer

MACRO VIEW
1. When The Stock Market Bounces, Rallies Should Be Sold by William Koldus, CFA, CAIA
2. Bank Of America Is #1... by Chris DeMuth Jr.
3. Effects Of The Coming Market Crash On The Economy - And Perhaps On You by
Larry Kummer

4. The One Key Indicator That Will Determine Market Direction by Bret Jensen

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|

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|
About Us

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Register for FREE to finish reading this article

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