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\*All rights reserved! Redistribution of this publication is strictly prohibited. There is substantial risk of loss in trading futures and options.
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There is substantial risk of loss in trading futures and options.
Past performance is not indicative of future results
On the radar:
▪ Decoupled stocks and oil will eventually be a positive for both markets.
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Did the stock market finally decouple from crude oil futures?
For as long as we can remember, the stock market and WTI crude oil futures have been moving in a positively correlated manner. This bucks conventional Main Street wisdom that suggests lower oil prices are good for the economy because it immediately increases the discretionary spending budget of most Americans. But in a post shale fracking boom, we are finding that the U.S. economy has largely benefited from the domestic oil boom…and now it must suffer from the bust.
As someone that grew up with a father working in the oil fields of South Eastern Utah, and a brother heavily involved in oil and gas extraction in New Mexico and Colorado, I’ve seen the results of commodity cycles on multiple occasions. The difference now, as opposed to the 1980s, the industry has expanded to levels that can have an impact on the overall economy. We can no longer enjoy lower prices at the pump knowing that our savings is contributing to layoffs and cutbacks across oil producing regions of the U.S. With that said, many oil producers needed a wake-up call.
Just a few years ago, oil field employees in the trenches laughed at the out of control spending from the higher-ups. I frequently heard stories of hundreds of thousands of dollars wasted on avoidable mistakes, carelessness, or a simple lack of experience. At times when oil is above $100 and businesses are flush with cash, these types of blunders are ignored, but in our new world of $30 oil, it cannot be tolerated. Unfortunately, in the commodity business low cycle prices are a necessity to clean things up. In the end, oil companies will operate much more efficiently; even if we don’t see $100 oil anytime soon, the trimmed fat and more frugal management decisions will enable oil companies to come back stronger than ever. Eventually, this will be a talking point for the stock market bulls, just as lower oil prices have driven equity bears in recent weeks.
As mentioned, oil futures and stocks have always been somewhat correlated, but in the previous 30 trading days the correlation coefficient has been running in the high 90s! In other words, the stock market and WTI crude oil have settled in the same direction roughly 95% of the time. A correlation this strong cannot possibly last, nor should it. Looking at a daily chart in which both crude oil futures and the S&P 500 futures are both plotted as overlays, it is easy to see ow the correlation came to life once the price of crude oil dipped below $40 per barrel. |
If you take the same settlement stats dating back 180 trading days, rather than 30, the correlation coefficient drops to about 50%. In more normal and healthy market conditions, the correlation should run at about 30%. A weekly chart of the oil/S&P correlation portrays a longer-term relationship between these two assets, and it is far from the near perfect correlation we saw for most of January.
Last Wednesday was the first day in a long while, it was clear that crude oil futures and stocks were attempting to decouple, and trade on their own fundamentals. In the long run, we believe this will be a positive development for both markets. After all, in today’s world of algorithm (machine) trading, when the computers see a down tick in one market, they sell the other, and vice versa. It is debatable which was the tail, and which was the dog, but it won’t matter if these markets finally stand on their own two feet. Over the long-haul, we are leaning higher in both the S&P and oil, but the correlation will have to continue to decouple for that to become a reality. Buyers in both arenas need to believe they are buying strong fundamentals, not just following the trading flavor of the month. |
It will take some time for the oil market to resolve itself; the previous trip into the $30s saw crude oil hover between $30 and $50 for three months before recovering. This time around, we’ve already seen a low near $26 per barrel, should this level give way, there isn’t anything stopping it until we see about $18. We aren’t expecting this to happen, in fact, we believe the mid-$26 area will continue to hold. After all, that is where the multi-year rally began in 2004. Even so, the odds favor a retest of those lows before a sustainable rally is possible. Although unlikely, S&P bulls should take a break below $26 in crude oil as a queue to be extremely cautious; crude in the teens would likely trigger temporary panic in the stock and bond markets.
A lot of smart people have tried to predict the turn in crude without success. Where it finally bottoms is anybody’s guess, but regardless of the exact price I am certain of one thing; prices this low are not sustainable in the long-run. Technical oscillators measuring market momentum such as the RSI (Relative Strength Index) and Williams %R, are at depths not seen in roughly two decades. In fact, prolonged readings in the RSI on a monthly chart under 30, and Williams %R under 20, are even more excessive than they were during the financial collapse of 2008. In 2008 the market was dealing with demand concerns, this time it is supply and currency valuation, but the commodity markets have a way of eventually curing themselves, and this will ultimately be no different. When crude does finally find a bottom, the bulls will be shooting for targets in the mid-to-high $50s, and eventually the down-trend resistance line which is projected to come into play in the mid-$70s. |
Despite what feels like breathtaking volatility taking place in the markets, our analysis of a monthly S&P chart reveals the market is nothing more, or less, than neutral. It isn’t as bad as the doom and gloomers believe it to be, but this certainly isn’t the time to be complacently bullish. Our favorite technical oscillators, RSI and Williams %R have fallen from extremely overbought levels, to merely impartial.
The S&P has become emotional; when markets begin acting swiftly on whim there aren’t many limits to how bad, or how good, things can get. At the moment, the S&P is on a healthy upswing but most market bottoms aren’t v-shaped, so it is reasonable to prepare for at least one more dip before things get comfortable again. According to our charts, a dip to the low 1800s would be standard. However, we cannot rule out a temporary plunge to the 1720 area to test the up-trend line that began in 2009, and hasn’t been tested since 2011. We’d prefer not to see the low 1700s print, but in reality it would probably be the healthiest move the market could make. At this price the weak hands would have likely folded, and the most patient dip buyers would be more willing to deploy sidelined cash. On the flip side, only a fresh break above 2100 would signal a continuation of the bull market. In our opinion, this is inevitable, we just aren’t certain it will be from the current level.
Conclusion
Market bottoms are messy, so there won’t be any stress free money to be made in either crude oil or the S&P, but we have to believe any large dip should be a comfortable place to get bullish in either arena. Be sure to keep plenty of ammo available. |
DeCarley Trading (a division of Zaner)
Twitter:@carleygarner
info@decarleytrading.com
1-866-790-TRADE(8723)
Seasonality is already factored into current prices, any references to such does not indicate future market action.
There is substantial risk of loss in trading futures and options. |
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