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Crude Oil Price and Stock Returns

Posted in Commodity Futures, Economic Indicators

Some market commentators cite the price of crude oil as an important indicator of future stock market behavior. Is expensive crude oil a sign of future inflation or a drag on aggregate corporate earnings, or is it a proxy for general economic strength? Does a local peak (valley) in the price of crude oil portend a falling (rising) overall stock market? Comparing the weekly crude oil spot price for the U.S. with the weekly level of the S&P 500 index for the period 1/97-8/07, we find that…

The following chart compares the weekly behavior of the crude oil spot price for the U.S. with the weekly level of the S&P 500 index. There is no obvious relationship between the two series, although both have mostly risen during the sample period. Sometimes they rise and fall together, and sometimes they move in opposite directions.

For more precise analysis, we compare weekly changes in the two series.

The following scatter plot relates the weekly change in the S&P 500 index to the weekly change in crude oil spot price for the U.S. No relationship is visually obvious. In fact, the Pearson correlation is -0.03 and the R-squared statistic is practically zero. On a weekly basis, the stock market generally ignores the price of oil.

Might stocks respond over longer periods to dramatic swings in crude oil prices?

The next scatter plot relates the 4-week future return for the S&P 500 index to U.S. crude oil spot price relative to its 12-week moving average (MA). When the latter measure is high (low), crude oil prices have recently risen (fallen). The chart shows a slight tendency for stocks to decline (advance) after the price of oil has risen (fallen). However, the Pearson correlation is a modest -0.18, and the R-squared statistic is just 0.03, indicating that variation in the price of oil explains only 3% of the variation in the S&P 500 index. When we use 12-week and 26-week future returns for the S&P 500 index, the relationship with relative crude oil price weakens.

The sample is not as large as implied by the number of data points because the return and moving average intervals are longer than the weekly sampling interval.

Might extreme moves in the price of oil be more predictive?

The final chart modifies the preceding one by ordering the changes in crude oil spot price from weakest to strongest, starting with 75% of its 12-week MA for the week ending 12/29/00 and ending with 134% of its 12-week MA for the week ending 4/2/99. For this chart we also select only every fourth data point to eliminate overlap of S&P 500 index return intervals.

The chart confirms a slight tendency for stock returns to be be weaker (stronger) after the price of oil has risen (fallen). The effect appears most significant after a recent dramatic decline in the price of oil. Specifically, the average 4-week change in the S&P 500 index is:

+0.9% for the entire thinned sample;

+3.9% when crude oil is < 90% of its 12-week MA (20 instances); and,

+0.2% when crude oil is > 110% of its 12-week MA (19 instances).

However, the 20 largest gains (losses) in the S&P 500 index occur with an average relative crude oil price of 97% (105%), suggesting that oil price is at most ancillary to stock market behavior.

In summary, while a dramatic move up (down) in the price of crude oil represents a modest near-term headwind (tailwind) for the overall stock market, oil price is generally not a good predictor of stock market behavior.

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