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September 18, 2019 / 6:26 PM / a month ago

Oil and Stocks’ Fickle Relationship

Every now and then, oil price swings come into the spotlight and a common myth typically follows: High oil prices spell doom for stocks. This fear often appears shortly after oil spikes in price or rises for a long period. The belief goes that oil and stocks are negatively correlated, so when oil is up, stocks must go down, and vice versa. But when you run the numbers, you can see that oil prices today won’t tell you much (or really anything) about where stocks will go in the future.

Spending Is Spending, Regardless

The prevailing though process says the US is too oil dependent and higher oil prices make life more expensive. Think about it: You need oil just to go about your daily life and get to work. So higher oil could mean you may pay more for gas, heating, airfare and have less money for other things. This higher cost could cause economy to slow and could reduce companies’ profitability—bad for stocks. A potential downward spiral! But take a step back and rethink that process.

First, we need to think globally. Money spent in the global economy contributes to global GDP no matter how it’s spent. If you spend your monthly budget of $400, the global economy won’t care whether you spend it on gasoline, clothes, groceries or model trains.

Oil producers or refiners may earn a little bit more (which may benefit their stocks) and other companies may earn a little less. Or maybe not. Maybe oil prices are rising because transportation costs are high, and transportation costs are high because demand for other products and resources is rising. Maybe firms instead make innovative gains that reduce their energy costs and increase their profits—pretty common in capitalist economies.

So What’s the Relationship? 

People worry that expensive gas hurts the economy, which means higher oil leads to lower stock prices. Then lower oil means we have more money to spend (so the thinking goes), which must be good for stocks. Right? Not so fast. Oil has risen alongside both rising and falling stocks. Oil has also fallen during both rising and falling stock environments.

In years when oil and stocks both rise or fall together, you might be tempted to conclude that oil and stocks actually have a positive correlation, meaning they move in similar directions. This is true—sometimes. Oil and stocks can also move opposite of one another at other periods of time—a negative correlation. But when we expand the test period out over nearly 40 years, the two actually have little-to-no correlation whatsoever. Don’t believe it?

Exhibit 1 shows monthly returns for US tocks and oil since 1980. To test correlation, we must find the correlation coefficient—a number that shows how much two things (in this case oil and stocks) move relative to one another. If the correlation coefficient is 1 or near 1, then the two variables move in near lockstep. They are positively correlated. If the correlation coefficient is near -1, then they move opposite of one another and have a negative correlation. If near 0, then there is no relation between the two variables.

Exhibit 1: Correlation (Or Lack Thereof) Between Oil and Stocks

 

Source: FactSet, as of 08/06/2019. S&P 500 Index total returns and West Texas Intermediate Oil Price (US$/Barrel) from 12/31/1979 to 07/31/2019.

The correlation between oil and stocks dating back to 1980 is just 0.079 [i]. Meaningless in our view. With a correlation near 0, oil and stocks have almost no relation whatsoever. While oil prices may disproportionately impact some firms’ stocks—like those in the Energy sector—oil and stocks just aren’t correlated strongly over long time periods.

Temporary Flings

While there is no long-term correlation, oil and stocks can be somewhat correlated over shorter time frames. But this can happen between any two things for short spurts. If you take professional football data and compared them to stock prices, you can likely find short periods when there seems to be some kind of relationship there. But these short flings are still meaningless and won’t help you be a better investor—Sorry, football fans.

Exhibit 2 shows 12-month rolling correlations between oil and stocks. Greater than zero means they are positively correlated, and less than zero means they are negatively correlated. Notice how for the most part the line oscillates volatilely between positive and negative correlation over the years. No perfect correlation either way!

Exhibit 2: No Correlation Between Oil Prices and US Stocks

 

Source: FactSet, Global Financial Data, Inc., as of 08/06/2019. S&P 500 Index total returns and West Texas Intermediate Oil Price (US$/Barrel) from 12/31/1979 to 07/31/2019.

Too often, folks use short periods of correlation like these to reinforce their existing biases. For example, if oil and stocks move opposite of each other for a short period, someone who already believed they were negatively correlated might look at that period as proof. Then they can conveniently block out other periods where that negative correlation doesn’t exist at all. This common cognitive error is called confirmation bias, and it can be dangerous in investing. Just remember—longer term, there is no correlation.

Going Different Ways

Oil prices—just like those of other commodities and even stocks—are driven by supply and demand. Higher demand from a booming economy could lead to potentially higher oil prices. In that case, stocks and oil prices might be rising alongside one another. On the other hand, oil could be rising due to constraints along the supply chain, which may not necessarily be a boon for the economy. Here, you might see stocks and oil prices diverging instead. Or, again, maybe not.

The fact is, knowing the future of oil prices along doesn’t tell you where stock prices will go. The two variables have very different supply drivers. While some demand drivers may overlap, others do not. The economy itself is incredibly complex, and using oversimplified rules like, “stocks go up when oil goes down” could be dangerous as a basis for your investing strategy.

Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return.  This document constitutes the general views of Fisher Investments and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.

[i] FactSet, Global Financial Data, Inc., as of 08/06/2019. S&P 500 Index total returns and West Texas Intermediate Oil Price (US$/Barrel) from 12/31/1979 to 07/31/2019

The Reuters editorial and news staff had no role in the production of this content. It was created by Reuters Plus, part of the commercial advertising group. To work with Reuters Plus, contact us here.

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