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Barron’s


Oil and Stocks are Locked Together in Vicious Death Spiral

by Chris Dieterich

Long-term prices for spot West Texas Intermediate crude oil (CLICK TO ENLARGE).

As crude goes, so goes the stock market.

The SPDR S&P 500 (SPY) is plunging another 2.6% in early trading on Tuesday, following the price of West Texas Intermediate crude. U.S. oil prices fell 4.5% to $28.23, a new low since 2003. The United States Oil Fund (USO), which owns short-term oil futures, sank by 4.5% — on pace for its third record close in a row.

Global oil markets remain oversupplied and without offsetting demand. That trend was confirmed again on early this week, after the International Energy Agency said that new exports from countries such as Iran will put “enormous strain” on a market already strained enormously in its ability to absorb more barrels of oil.

John Kosar, director of research at technical analysis firm Asbury Research, notes the astoundingly tight correlation in recent weeks between the spot prices for West Texas Intermediate and the S&P 500. His simple correlation calculation shows a 0.92 correlation between the two in January (a reading of 0 indicates stocks are moving with no relationship, while 1 means gains or losses in perfect unison). Kosar told Barron’s that he ran the numbers back two decades and couldn’t find another period where the correlation exceeded 0.7:

“People talk about it like crude oil and stocks have always been correlated — they haven’t; this is something that’s relatively new. This is what the market is watching, and this is the historical significance of breaking under $30.”

Here’s more from Kosar’s Tuesday report:

“This positive correlation did not statistically exist as recently as the beginning of Q4 2015 but has jumped to 0.92 between the S&P 500 (SPX) and West Texas Intermediate spot crude oil as of January.

Although no one knows how long this correlation will remain intact, especially since there has been no statistically significant long-term correlation between oil prices and US equities, for the time being it warrants our attention.

This breakdown theoretically clears the way for an deeper decline, potentially to the next long term underlying support level which is at the $17.48 per barrel November 2001 closing low.

This certainly does not mean that oil prices have to or should get that low, but financial asset prices do typically weaken further once major benchmark lows — like $30.81 in WTI crude — are broken.  Therefore, as long as oil prices and the S&P 500 remain positively correlated, this most recent breakdown in the price of crude oil portends at least more near term weakness in the US stock market.”

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