Musings: Crude Oil Prices Track Stock Market Performance



Green shoots or not, the stock market and crude oil futures have developed a symbiotic relationship over the past year. In fact, many Wall Street sages remark on how oil prices seem to have merely followed the daily movements of the Dow Jones Industrial Average (DJIA) since the middle of 2008. Since the broad stock market is known to be a leading indicator for economic activity, it is not surprising that there would be a relatively close relationship between these two measures.

Wall Street sages remark on how oil prices seem to have merely followed the daily movements of the DJIA since the middle of 2008

As shown in the accompanying chart, the stock market, as measured by the DJIA, essentially traded sideways from the beginning of 2007 through to the fall of that year. During that time, crude oil futures were steadily climbing from slightly under $60 a barrel to the $80 threshold. At that point, the stock market peaked. After oil prices traded above $80 and then pulled back to that price point suggesting that there was real support in the market for oil prices to hold at that level and probably move higher, the stock market began a course of setting lower highs and lower lows - a notoriously bearish technical trading pattern. As oil prices moved from $80 a barrel into the $90s, the stock market began sliding, but it rallied when crude oil fell back toward the high $80s.

After oil prices traded above $80 the stock market began a course of setting lower highs and lower lows – a notoriously bearish technical trading pattern

The stock market rally was snuffed out as crude resumed its upward march and touched $100 a barrel. Another oil price retreat followed by a sideways move in the $90 a barrel range helped the stock market to stabilize. At that point, both the stock market and oil prices rose in concert until oil was solidly across the $120 a barrel threshold. It was at that point in late spring that Bear Sterns collapsed and credit markets began to come under significant stress. As the stock market fell, crude oil price continued to rise marking another period of disconnect. The last surge in crude oil prices probably reflected investor concern about the safety of financial instruments and the value of the U.S. dollar so the move into commodities as a hedge gained greater credibility and desirability.

After oil prices traded above $80 the stock market began a course of setting lower highs and lower lows – a notoriously bearish technical trading pattern

While it took a little while for oil prices to correct and catch up with the falling stock market, the pattern of oil prices following stock prices seemed to be established. That pattern appears to be well entrenched today as one can see the almost daily movements of the DJIA being mirrored in the action in crude oil futures prices.

Exhibit5"

Given this lockstep pattern of crude oil futures following the stock market, it becomes much more important to be watching those factors that may influence the stock market's future trading than the daily machinations about crude oil supply and demand and inventories. If so, then the recent analysis by Morgan Stanley of bear market trading patterns becomes important.

Exhibit6"

Morgan Stanley analyzed 19 different bear market trading patterns (they also looked at one gold market) and determined that on average market prices fell by 56% over a 29-month period in the first stage of the bear market and then rebounded by 70% over the following 17 months. (Numerous charts and financial industry stories use the Morgan Stanley chart. Why the data on the chart differs from the data in the table they published we cannot explain, however the conclusions remain the same.)

Exhibit7"
The stock market might be signaling that crude oil prices, after a consolidation period in the low $70s a barrel, have further to rise, maybe solidly back above $85 or even possibly toward $100 a barrel

In the current bear market, the broad market fell by 57% over 17 months from the October 2007 peak. It subsequently rebounded by 49% over the five months from the March 2009 lows to the initial rally end of August 7th. By historical measures, the current stock market rally, while temporarily in a pause, is not over and could last into early 2010. If so, then the stock market might be signaling that crude oil prices, after a consolidation period in the low $70s a barrel, have further to rise, maybe solidly back above $85 or even possibly toward $100 a barrel. If this doesn't give one heady thoughts about energy stocks and future energy company earnings then probably nothing will!