Oil Crash Signal Flashing Again

Stocks tend to outperform after periods of high-stocks/low-oil prices

Senior Quantitative Analyst
Jun 28, 2017 at 6:30 AM
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Oil is struggling while major stock indexes are just off all-time highs. Some investors are worried that it’s just a matter of time before the oil woes affect the stock market. Others say there's no need to worry because crude prices are being driven by supply, not demand. As usual, I’ll spare you my opinion on it. Instead, I’ll look at the historical record to see what happened after similar high-stocks/low-oil signals.

Stocks After a Signal

To define a measurable signal, I looked at the percent rank of the S&P 500 Index (SPX) and the spot price of oil over the past year. For the analysis, I looked at instances when the stock index was in the 90th percentile of its annual range, and oil was below the 25th percentile of its annual range. Basically, when stocks were high and oil was low. This gave 14 prior occurrences since 1980. The table below summarizes how the S&P 500 Index performed after these signals compared to typical returns.

In these prior instances, oil did not drag down the stock market. Looking out further than a month, the stock market index performed better than usual when looking at the average return and percent positive. Over the next year after a signal, the SPX averaged a gain of over 14%, with positive returns over 90% of the time. Also, the standard deviation of returns was significantly reduced, pointing to lower-than-usual volatility.

                                        IOTW Charts 1 and 2 June 27

In the table below, I show the individual occurrences. The first signal happened in late 1980, after which stocks struggled. The S&P 500 Index fell about 6.5% over the next 12 months. All 13 times since then, the S&P 500 Index has been higher a year after a signal. The last eight times, the index was higher over the next six months. Hopefully this trend continues. In the current bull market, since 2009, this is the third signal we’ve seen; the other two both occurred in 2014.

                                          IOTW Chart 3 June 27

Oil Prices Could Underperform in the Long Term

Stocks have done well after these signals. Does that mean oil has tended to do well? The answer to that is mixed. The table below summarizes how oil has performed after these signals compared to their usual returns.

It seems oil prices have tended to surge higher after one of these signals, as three-month returns have easily beat typical returns. Three months after a signal, oil averaged a gain of 4.85% and was positive 79% of the time. This easily beats its usual three-month return. However, after those three months, oil has tended to slow down.

The six-month average return after a signal is only slightly higher than the three-month return, indicating some weakness. Then, you can see some significant underperformance when comparing one-year returns after a signal to usual crude returns. Oil typically ends the year higher half the time, averaging a gain of 5.70%, but after one of these signals, the commodity has lost an average of 1.53%, and was positive just 43% of the time.

                                          IOTW Charts 4 and 5 June 27

As I did for stocks above, below I list the individual returns for oil prices after one of these signals. The returns seem very random, with the last signal leading to an immediate collapse in the price of oil.

                                                 IOTW Chart 6 June 27

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