Are Oil Prices Related to the Stock Market?

With all the recent headline news about oil prices and the stock market, I thought I should write this month about the correlation between the two. However, let me start out by talking about how the financial media tends to sensationalize the news.

I had the opportunity to sit down with someone who had been selected to talk on CNBC and it was enlightening. This person was the chief economist of a mutual fund company and he told me about how CNBC found their speakers (those that weren’t paying money to be on). He said they call around the night before and morning of the show to a list of possible speakers and ask them for a response to a financial question. Then they typically select the two most extreme opposite views and put them on the air. The people who can see both sides or have a balanced answer are not picked. This means that all most people see are extremist viewpoints on financial topics by so-called ‘experts’. It would be like listening to a extreme right wing Republican debate with a extreme left wing liberal. Pretty useless viewpoints, in my personal opinion.

So when it comes to oil and the talking head on CNBC says, “the stock market is down today because the price of oil is down”, I researched if that was really the case. If we look at the past three months, it appears the answer is a resounding “YES”. Here is a graph of the ETF United States Brent Oil (BNO) (blue line) versus the Dow Jones (red line):

While BNO has fallen considerably more than the Dow Jones Industrial Average, the movements have been incredibly similar. The technical term for that is a high ‘correlation’.  So looking at charts like this mean that the talking heads on CNBC are right and there is a relationship?  Not Really…

According to a January article by MarketWatch’s Wallace Witkowski, citing Covergex research, the long-term correlation between oil prices and stocks going back to 1973 has been almost zero or negative 1.1%. So basically, for more than 40 years, oil and stock prices have usually moved independent of each other.

So why now? Why the correlation in recent months?  There are many hypothesis trying to explain the recent correlation, but it is all merely theory.  My personal opinion is that since China is one of the biggest consumers of oil and they are using less is another indication of their economy slowing down.  If China slows down, then several industries that sell to China will have lower earnings than expected, which brings down their stock price.  Also, several financial institutions that loaned money to oil companies may be in jeopardy of not getting their loans repaid, which could hurt the financial system.  However, the US economy is roughly 70% consumer spending driven, so lower prices should eventually be a good thing.

It will be interesting to see how this all plays out… For now, ignore the talking heads about oil prices and the stock market.  The recent correlation is an anomaly, in my mind.