Equity/Oil Correlation Back To Historically High Levels by Eric Bush, CFA 

Back in June, we commented how the historically high correlation between equity prices and oil prices that occurred in the first quarter had moderated somewhat. Well, that moderation has reversed and the relationship between the two is basically back to being as tight has it has ever been since 1980. As was the case early this year, Asian equity prices are much more decoupled from oil prices than North American or European counterparts. This time around, however, some unlikely sectors are trading tighter to oil prices than ever before.

Equity Prices, Oil Prices, Equity-Oil Correlation

Equity Prices, Oil Prices, Equity-Oil Correlation

Equity Prices, Oil Prices, Equity-Oil Correlation

Equity Prices, Oil Prices, Equity-Oil Correlation

Equity Prices – Oil Prices Correlation

Investors expect late cyclical sectors (energy, materials and industrial) to have a high correlation to equity prices and currently these sectors aren’t disappointing on this front. The current environment is quite different, however, than what existed prior to 2015. Take energy as an example. The sector that is most intuitively tied to oil prices. It makes sense that energy companies should outperform when oil (or commodity prices) in general rise. The correlation between energy equity prices and oil is basically as high as it has ever been with the 200-day correlation at 66%. In comparison, the average 200-day correlation from 2004-2014 was just 4% (the median was also 4%)!

Equity Prices, Oil Prices, Equity-Oil Correlation

Equity Prices, Oil Prices, Equity-Oil Correlation

Equity Prices, Oil Prices, Equity-Oil Correlation

There has been a creeping higher correlation occurring with other sectors as well. The 65-day correlation between tech stocks and oil prices is at an all-time high of 46% and the 200-day correlation is also basically at an all-time high. Consumer discretionary and telecom stocks, which tended to have a slight negative correlation to oil prices prior to the financial crises now exhibit 200-day correlations of 40% (and rising).

Equity Prices, Oil Prices, Equity-Oil Correlation

Equity Prices, Oil Prices, Equity-Oil Correlation

Equity Prices, Oil Prices, Equity-Oil Correlation

So while US oil production is down about 15% since making a high in July 2015, it is a bit surprising to see that crude and petroleum products inventory (excluding SPR) continues to make new all-time highs pretty much every week. If history is any guide this increase in US oil supply is a negative sign for oil prices. And so if we assume lower oil prices may be on the horizon, equity investors would be smart to flock to Asia where seven out of 10 sectors have a 200-day correlation to oil less than 10% (the three Asian sectors with the highest correlation to oil prices are energy (26%), financials (15%) and materials (18%). Asian equities should provide the diversification investors are looking for if oil prices test 2016 lows.

Equity Prices, Oil Prices, Equity-Oil Correlation

Equity Prices, Oil Prices, Equity-Oil Correlation