Breakdown of the positive oil-equity correlation?

Author: Michael Arold

Covestor model: Technical Swing

Disclosure: Long LULU

Recently, an article on Reuters posited that “oil and stock markets are likely to delink this year.” What does that delink mean for stocks?

When looking at a price chart of the two, it is quite obvious that oil and stocks have been highly correlated for the last two years. Since May, however, crude has lost over over twenty percent in value while the S&P 500 lost only about six percent (as of 6/28). Assuming a constant correlation between the two, one would conclude that stocks would need to come down further.

Of course, reality is a little bit more complex. Historically, there have been periods when oil declined while stocks rose. These phases of inverse correlation coupled with rising equity prices didn’t happen often during the last 10 years – I count just two periods, and when they occurred they only lasted for a couple of months. The following overlay of the S&P 500 and crude prices shows these phases – click to enlarge:

correlation of oil and stocks


Why are rising oil prices sometimes positive for stocks and sometimes taken as a negative? Markets are driven by the mood and emotions of investors. Higher oil can mean a booming economy, but also higher costs for consumers and companies. Markets frequently switch between seeing the glass half full and half empty and it is the task of the investor to analyze these mood swings.

In any case, if the trend of the last two months continues, stocks in the discretionary sector are likely to outperform, since lower oil prices mean more money in the pockets of consumers. In fact, this is what we have seen in the last two weeks. As of end of day June 28, the Consumer Discretionary sector ETF (XLY) is up over four percent since June 13 (from $38.11 to $39.89), while energy stocks (XLE) are up just over one percent (from $73.33 to $74.25). (Source: Google Finance)

As a consequence, I’m looking for investments in the retail sector: Lululemon Athletica (LULU) is the latest addition to my Covestor model portfolio and a market pullback would offer additional entry opportunities.


“Analysis: Oil and stockmarkets likely to delink this year” Simon Falush and Christopher Johnson, Reuters 5/30/11