Is The Oil & Equity Correlation Signaling A Shift In Supply-Side Sentiment?

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Is The Oil & Equity Correlation Signaling A Shift In Supply-Side Sentiment?

Is The Oil & Equity Correlation Signaling A Shift In Supply-Side Sentiment? by Rashad Ahmed

Rising Correlations and Oil’s Equity Beta

The rising correlation between crude oil and U.S. equities has been getting quite a bit of attention lately (here and here etc). Though estimates are near highs, correlations haven’t surpassed levels seen during the European Sovereign Debt Crisis or the Global Financial Crisis of 2008, meaning we may not be at the top of the staircase just yet.

The relative risk between oil and equity prices captured by oil’s equity beta, however, is at record levels. Meaning on average, stock price sensitivity per unit move in oil (and vice versa) is at all-time highs. Historically, the correlation and beta between crude oil and stocks tend to rise during periods of market stress and crisis, e.g. when demand-side risk heightens. Equities and oil share similar demand-side risk profiles, as capital seeking (fleeing) risky, inflationary or pro-growth investments flow in (out) of both asset classes. Given the current macroeconomic environment, uncertainties on the demand-side from continued Fed tightening, deflationary headwinds, and currency devaluations/stronger USD will continue to weigh down on both assets. Still, these extreme levels of co-movement do not sustain themselves, and as markets calm down correlations and betas subside back towards historical averages.

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