Crude-oil futures and the U.S. stock market are linked in a strange dance. Lately, oil has been moving nearly in lock step with equities. The correlation over the past month has been uncanny.
In statistical terms, correlation is defined as the tendency of assets to move in the same direction over a given period. Perfect positive correlation, in which two securities move in complete lock step, is represented by the value 1. In perfect negative correlation, represented by negative 1, securities move in exactly opposite directions. A correlation of zero means price movements by the securities are completely random and independent of each other.
Since late August, crude oil
and the Dow Jones Industrial Average
have been mostly positively correlated. As the chart below highlights, as oil (in red) has gone so have stock indexes like the Dow (in blue):
Those moves intensified as turmoil in China markets reached a crescendo. According to Dow Jones data, since Aug. 19 this year oil has moved in the same direction as the Dow more than 70% of the time. Compared with 51.98% for all of 2014 and more than 57% in 2015, not including Wednesday’s trade. The table below highlights that trend:
Wednesday’s action saw stocks retreat after oil turned lower in afternoon trade.
This isn’t the typical relationship between the two assets. According to a January article by MarketWatch’s Wallace Witkowski, citing Covergex research, the long-term correlation between oil prices and stocks going back to 1973 has been almost zero or negative 1.1%. In other words, for more than 40 years, oil and stock prices have usually moved independent of each other.
Read: Oil is unlikely to return to $100 a barrel for years
Lately, however, plunging oil has been blamed for leading the stock market lower, particularly after some investors were caught flat-footed by the accelerated decline of the commodity beginning last November.
Read: Oil sinks as traders bet that inventories will soon climb
So what’s driving this pattern now and will it last?
Fawad Razaqzada, market analyst at Forex.com, pointed to turmoil in China sparking a risk-off mentality. Meaning, investors have been shunning assets that are perceived as risky or volatile, including oil and stocks, in favor of haven assets.
“You tend to see risk assets fall across the board during volatile times,” Razaqzada said.
Tariq Zahir, managing member of investment-advisory firm Tyche Capital Advisors, said he attributes some of the tandem moves by oil and stocks to worries about the Federal Reserves’s interest-rate decision and seasonally slow summer trading volume. “A lot of people still weren’t back at their desks,” he said.
But this oil-stock marriage may end soon, Zahir bets.
He sees an eventual hike of benchmark rates by the Fed lifting the dollar and weighing on dollar-denominated oil, but also believes that oil could start to see more independent moves lower driven by expected growth in oil inventories given that the summer-driving season has come to an end.
Read: 4 reasons behind oil’s latest price drop
Fears about sluggish global growth and the collapse of the high-paying energy jobs, which had been a big boost to the market earlier, could also be behind these recent moves.
Ultimately, cheap oil could eventually prove a boon to the stock market, driving consumers to spend more of their oil savings elsewhere. But, so far that dynamic hasn’t quite played out.