About That Oil & Stock Market Correlation

The price of oil seems to be at the forefront of every market and economic conversation these days. That tends to happen when one of the most important commodities on the planet falls 80% in a short period of time. Is it too much supply? Not enough demand? The pricing in of future technological advancements? Speculators? No one really knows, but it’s likely not one factor that’s caused this massive repricing.

Regardless of the reasons, market participants are paying attention. Per the Wall Street Journal yesterday, the correlation between stock prices and oil prices have reached a new all-time high this month:

The correlation between daily moves in the price of Brent and the S&P 500 stock index is at levels not seen in the past 26 years. January isn’t over yet, but over the past 20 trading days—an average month—the correlation is 0.97, higher than any calendar month since 1990, according to data from both benchmarks examined by The Wall Street Journal. A correlation of 1 would mean oil and stock prices move by the same proportion in the same direction, while a correlation of minus 1 would mean they move proportionally in opposite directions.

This seems like a pretty scary statistic, but when you look at the daily returns of the S&P 500 and oil prices it’s much harder to find as close of a relationship as they a laying out:

Screen Shot 2016-01-26 at 9.57.31 AM

While there have been days when both have risen and fallen at the same time it’s hard to claim that the magnitude of the moves in stock prices has been anywhere near the moves in oil. If you were to look at the standard deviation in returns, oil has had roughly four times the volatility as stock prices.

The problem here is that correlation can be a crude statistic (sorry, I couldn’t help myself). Correlation provides a statistical relationship of price movements but it’s not perfect. Even if correlations between assets are trending higher that doesn’t mean that the outcomes have to be even remotely similar. While stocks are down around 8% this year, oil has fallen nearly 20%.

You also have to put into perspective the fact that we’re dealing with two highly volatile assets here that have a highly volatile historical relationship. See the rolling 90 day correlation between stocks and oil going back to the early 1980s:

Screen Shot 2016-01-26 at 10.11.13 AM

The correlation swings wildly from positive to negative to no correlation whatsoever.

It’s hard to believe, but this drawdown in oil is not as unheard of as it may seem. Every single decade going back to the 1980s has experienced a bone-crushing crash in the price of oil. Here are the largest drawdowns by decade:

  • 1980s: -67%
  • 1990s: -72%
  • 2000s: -76%
  • 2010s: -80%

There are many conclusions being drawn at the moment about the price of oil and its impact on the financial markets. My take is that it’s nearly impossible to have any hard and fast rules with this type of thing when there are so many moving parts to consider. There have been obvious psychological issues on market sentiment and there will surely be economic consequences when all is said and done.

But when you’re dealing with extreme volatility it’s difficult to determine the difference between the price and the narrative.

Source:
Oil, Stocks at Highest Correlation in 26 Years (WSJ)

Further Reading:
A Lesson in Portfolio Correlations

This content, which contains security-related opinions and/or information, is provided for informational purposes only and should not be relied upon in any manner as professional advice, or an endorsement of any practices, products or services. There can be no guarantees or assurances that the views expressed here will be applicable for any particular facts or circumstances, and should not be relied upon in any manner. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment.

The commentary in this “post” (including any related blog, podcasts, videos, and social media) reflects the personal opinions, viewpoints, and analyses of the Ritholtz Wealth Management employees providing such comments, and should not be regarded the views of Ritholtz Wealth Management LLC. or its respective affiliates or as a description of advisory services provided by Ritholtz Wealth Management or performance returns of any Ritholtz Wealth Management Investments client.

References to any securities or digital assets, or performance data, are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

The Compound Media, Inc., an affiliate of Ritholtz Wealth Management, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. Investments in securities involve the risk of loss. For additional advertisement disclaimers see here: https://www.ritholtzwealth.com/advertising-disclaimers

Please see disclosures here.

What's been said:

Discussions found on the web
  1. Jim commented on Jan 26

    Finally sanity. Fisher investments has an article with the same sentiment.