The Stock Market Can Cook Even When Oil Is Hot

6/23/2009


Anybody who follows the financial media has heard pundits warn that high oil prices are bad for the stock market.

That’s not a new sentiment — I remember hearing similar tunes back in 2004, and in 1999 (when per-barrel prices more than doubled), and in 1996, all good years for stocks. Even back in my high-school and college years in the 1980s, headlines decried rising oil prices as evil.

A look at the numbers suggests many market watchers are not doing their homework. Over the last 23 years, stocks have bucked conventional wisdom — oil prices and stock prices have moved in the same direction in 57% of the last 270 rolling 12-month periods.

That statement deserves a moment to stand alone, but before you go out and buy up stocks just because oil prices are rising, consider these three points:

The relationship between oil and stock prices is far from perfect. Oil-price gains in 2002, 1994, and 1990 weren’t so friendly to stocks.

The relationship between oil and stock prices is relatively weak. The correlation coefficient between 12-month changes in oil prices and the S&P 500 is 30%. This suggests that while the two variables tend to move together, the change in one explains only about 9% of the change in the other.

What’s good for energy can be good for business. Did the rally in oil prices from mid-2003 to mid-2007 cause the S&P 500 to increase 54% during that period? Of course not. But we shouldn’t be surprised at such parallel moves because some of the factors that keep oil prices high are good for industry as a whole. Yes, fuel represents a major cost to many businesses. But oil prices tend to rise when demand is high — and demand for oil tends to be high when business is good.

My goal here is not to advise subscribers to buy aggressively when oil prices are high. Instead, I suggest that while you should pay attention to oil prices because they tell you a lot about many facets of the market, you should not make buy or sell decisions based on them. Don’t let low oil prices get you to drooling over stocks, but also don’t let high oil prices drive you to sell. Even energy stocks, which move more closely in line with oil prices than the broader market, may be worth holding during periods of weak oil prices.

Most experts would agree that last year’s per-barrel oil prices of $120 or $150 were unsustainably high and not particularly healthy. But oil could rise quite a bit from current levels near $70 per barrel before we would consider it a danger sign for stocks.


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