Is Oil Driving The Stock Market? And Should Traders Care?

Recent headlines imply that the slump in the oil market caused the January drop in global stocks. They also point to oil rallies as the reason for stock rallies. But is the relationship causation or just correlation? Should we say one happened “and” or “because” the other one did?

Early in the Wednesday US trading session, crude oil futures dropped by nearly a dollar a barrel and the S&P 500 quickly moved in lockstep, dropping over 40 points in the same hour.

The larger downward trend of Monday and Tuesday in oil was also mirrored in the stock market. Crude oil’s drop was a full 11%, the largest percentage drop since March 2009. However, the drop in stocks over those two days was not nearly as dramatic.

On Wednesday, the markets diverged in the morning. Crude had a brief selloff when the weekly EIA Petroleum Status Report came out, but then it bounced and an hour later WTI crude oil futures (Nadex: Crude Oil) had pushed above $31 a barrel and come within 20 cents of $32.

Stocks only came along for half of that ride. The S&P 500 US dropped 40 points, but only regained half of that loss. While oil was rising to two-day highs, stocks hovered near Tuesday’s lows. Clearly the exuberance among crude oil traders had not inspired similar optimism among stock index futures traders or investors as a whole.

Later in the day stocks did rally, but at the day’s close, crude oil was up over 8% and equity indexes were unchanged. Clearly stock traders were not taking their cues from the bullishness of oil traders. In fact, it’s hard to say what crude oil traders were using to guide their decisions on Wednesday.

Why were oil traders so bullish following a fairly downbeat EIA report? You’d have to do some mental gymnastics to come up with a direct reason. The record supply glut set a new record, with global oil inventories rising to over half a billion barrels and driving up gasoline inventories as well.

Foreign output remains high, with Iran now adding more of its stockpiles and production to the world market. And with large inventories and weak demand, refineries are cutting back production.

The weak demand comes despite the low prices. Demand for gasoline is off 0.9% year on year, despite gas prices being down 25% from this time in 2015. Demand for heating oil and distillates is down a full 16%, thanks to a warm winter and weak industrial demand. That perception of industrial weakness got further proof with Monday’s weak ISM Manufacturing Index report, the fourth weak report in a row and the worst streak of manufacturing numbers since 2009.

And despite that substantial negative report, the bulls had the day in crude oil. And even though stocks ended flat, some analysts will say that crude oil’s rally had a delayed effect on stocks and caused the afternoon rally.

When crude oil’s price action doesn’t even seem to have a logical connection to the latest supply and demand report, is it reasonable to think that stock traders are tying their decisions to such an emotional and unpredictable market?

Stock traders aren’t showing much consistency in their reactions to the news, themselves. The recent earnings reports were overall positive among S&P 500 companies, indicating that US businesses continue to be profitable. Yet some are pointing to earnings per share as a problem sign. A report from Goldman Sachs even said that profit margins are too high and if they don’t go down and revert to the mean, they believe it raises questions about “the efficacy of capitalism” itself.

It is a time when short-term traders who simply watch price movement tend to have an advantage. On Nadex, binary option and spread traders can trade the ups and downs without speculating on the whys and wherefores. Sometimes that is best left to the analysts. For traders, explaining the move isn’t nearly as important as trading it.

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