### Oil Futures Term Structure and Future Stock Market Returns

**November 16, 2016** - Commodity Futures, Equity Premium

Does the term structure of crude oil futures predict stock market returns? In their October 2016 paper entitled “Do Oil Futures Prices Predict Stock Returns?”, I-Hsuan Chiang and Keener Hughen examine the ability of crude oil futures prices to predict U.S. stock market returns. They identify the first three principal components of the nearest six oil futures prices. After finding that one of these components (related to the term structure) predicts stock market returns, they define a simple oil futures term structure curvature factor as:

- Short-term slope (natural logarithm of the second nearest price minus natural logarithm of the nearest price), minus
- Long-term slope (natural logarithm of the sixth nearest price minus natural logarithm of the third nearest price).

They test the ability of this curvature factor to predict U.S. stock market performance and industry performance in-sample (based on returns) and out-of-sample (based on R-squared explanatory power) at a one-month horizon. They compare its out-of-sample predictive power with those of nine other widely used predictors: dividend-price ratio, dividend yield, earnings-price ratio, book-to-market ratio, long-term U.S. Treasuries yield, long-term U.S. Treasuries return, U.S. Treasuries yield spread, U.S. Treasury bills yield and default yield spread. Using daily prices for the six nearest WTI light crude oil futures contracts and monthly returns for the broad U.S. stock market, 49 value-weighted industries and stocks in four crude oil subsectors during March 1983 through December 2014, *they find that:* Keep Reading