Why should the stock market move in tandem with the price of oil? If you’ve never before heard that it has been you may think that the world really has gone crazy. Of course, you might be right.
But the phenom has been so strong and so enduring, lasting nearly two months now, that it’s more than a bizarre intellectual exercise – there’s a lot of money at stake. So what’s so important about oil going up that it drives the market? And how long will this keep up?
There are a few good theories out there for the first question, none of which make a strong case for when this relationship will break and we’ll go back to “cheap oil is good”. But there may be an even simpler way to look at it which tells us that the current situation can’t hold for very long at all.
Stocks have been down for all of 2016 for reasons that Barataria has described as “because”. It’s a pause, the theory goes, a welcome break fueled by nervousness over China, retail spending, lower profits, and baggage retrieval system at Heathrow. Every market has to at least take a pause once in a while, and the cyclical bull that’s been running since 2010 was getting pretty old by any measure.
But to hook up with the price of oil? That’s just crazy.
The standard measure of oil is West Texas Intermediate (WTI). This is the price of crude oil of intermediate quality in Cushing, Oklahoma. It’s simply a convenient standard. We’ve written about this many times as Barataria tried, desperately, to tell everyone that oil can’t possibly go below $80, then $60, then $50 per barrel. It’s at about $30 now. Mazeltov.
The first concern that moved stocks with oils was the fear that the junk bonds floated to frack the bejaysus out of North Dakota were going to fail. This is still a valid concern, but investors have had more than a year now to price the potential $336B loss into their business. It’s almost certainly taken care of.
Is it possible that robots are to blame? After all, they learn through AI the patterns of the market and then apply them, which is to say repeat all the bad habits of humans ad infinitum. It’s an interesting theory that suggests the two will be stuck together for a long time – at least until someone makes a killing going against the ‘bots.
Some random blogger named “Ben Bernanke”, writing for the Brookings Institution, has a much more elaborate and good reason. It’s not that stocks are hurt by low oil prices, he tells us, as they are both hurt by the same decrease in demand worldwide. The theory is that reduced demand is what’s killing oil and China both – and will ultimately crash the stock market.
Correlation does not imply causality, so the theory is sound. But it doesn’t check out entirely.
The best Bernanke can correlate stocks and oil going back to 2011 is 0.43, a weak correlation at best. That’s after he takes into account the fact that only 45% of the drop in oil prices can be explained by weakening demand and fudging the whole sundae with a correlation through the volatility index (VIX). Others, looking for the same correlation, found that it only gets weaker if you look back to 2000 or so. There’s no good reason for oil to correlate with stocks other than negatively, as cheap oil is good for consumers.
That brings us to one of the things we know is spooking the market, which is the relatively weak retail sales figures in 2015. The chart below shows the year-over-year change in retail sales since 2000:
From this, we can see that a healthy economy, circa 2000, sees retail sales grow between 5% and 10% every year. Between official recessions, specifically 2004-2006, we hit that level again. Outside of a rebound after a disastrous 2007-2010, we haven’t been above 5% growth per year. It’s the thing that many point to as holding back GDP growth as the most sensitive part of overall consumer spending figures. So it’s been watched very carefully for signs of a genuine rebound.
In 2014 it averaged 4.3% growth, but in 2015 only 1.5%. That is bad.
Then again, we have to remember that gasoline is about 10% of all retail sales. A drop in gasoline prices of about 35% will show up as a drop in retail sales of 3.5%, roughly. The figures from 2015 are actually rather strong if you add this back in – a feature we see at the tail end of the chart this January, where we are comparing two post-drop periods for the first time.
So by the middle of the year consumer spending may well be looking like it did back about 2006 or so, which is to say above 5% for the first time that isn’t just a crash rebound.
That’s when we can expect low oil to stop correlating with the stock market. This still points to sometime this summer or so, which is to say when oil prices typically rebound just a little bit for summer driving season.
Whether buying stocks or simply seeing the USA in your Chevrolet, please fasten your seatbelts and have a nice trip!