Invest In Asia, Health Care To Reduce Your Correlation To Oil Prices by Eric Bush, CFA – Gavekal Capital Blog

We have written about the historically high current correlation between oil prices and stock prices several times recently (see here and here). Correlation between oil prices and stock prices continues to increase as the 65-day correlation and 200-day correlation are once again making new highs going back to 1980. The 65-day correlation currently stands at 58% (prior to 2015 the previous high was in 1982 and was only 38%) and the 200-day correlation has increased to 47% (prior to 2015 the previous high was also in 1982 at just 28%).

Oil Prices

Correlation Between Oil Prices And MSCI World Index

Today, we wanted to tackle this issue from a slightly different angle and look at how different regions and sectors of the equity market are currently moving in relation to prices of oil. We will be using our GKCI Index data for this exercise and for this purpose this series only goes back to 2004. In the chart below, we show the correlation between oil prices and the GKCI DM Index. As you can see, the GKCI DM is very similar to the MSCI World Index as the 65-day correlation to oil stands at 56% and the 200-day correlation is 47%.
1 - Copy - Copy

If we began to decompose the stock market by region we see there remains a very high correlation to oil if one is invested in the DM Americas or DM EMEA. In both of theses cases, the current correlation level is far above the usual range since 2004. If investors are looking to dramatically reduce their portfolios correlation to oil prices then they need to be investing in DM Asia. There is basically zero correlation currently between oil prices and GKCI DM Asia Index. In fact, the current correlation levels are dramatically lower than they were from the 2009-2011 period.

1 - Copy (2) - Copy

1 - Copy (2)

1 - Copy

Moving over to the emerging part of the world, the current correlation between oil prices and EM stocks is high but it isn’t making all-time highs like we are seeing in DM stocks. However, once again we are seeing some significant regional differences.  EM Americas and EM EMEA are both basically making 12-year highs while EM Asia’s correlation to prices of oil is pretty much in the range it as always been in since 2004.

1

2 - Copy (2)

2 - Copy

2

Lastly, some interesting data points emerge when we look at the correlation between oil prices and various DM sectors. It intuitively makes sense that the energy sector and oil prices would be highly correlated. However, we believe the degree to which they are currently correlated will surprise even those investors that follow that sector closely. The current 65-day correlation stands 76% and the current 200-day correlation is 63%. The 65-day correlation is more than twice as high as any correlation prior to 2015 and the 200-day correlation is more than three times as high as any correlation prior to 2015. As the second chart below shows, a similar trend is playing out for material stocks as well.

3

4

For all the talk about how lower oil prices are dragging down financials (or more specifically bank) stock prices, the correlation data doesn’t completely back that story up. Yes it is true that financials and banks specifically currently have a historically high correlation to oil prices. However, it is pretty much at the same correlation level that the market in general has with oil prices at the moment. However, it should be noted that financials currently have the 3rd highest correlation to oil prices of any sector and surprisingly has a higher correlation to oil prices than industrials.  In order to reduce your correlation to oil, your best bet is to be invested in health care, utilities, consumer staples, and information technology (in that order).

9

10

5

6

7

8