Where Will The S&P 500 Index Be If Crude Oil Rallies To $40?

The recent price action and volatility in the market has been highly correlated with the fluctuations in Crude Oil futures. Look no further, than the exact day the recent lows were made in both instruments. Both bottomed on the exact same day, February 11, when the March S&P 500 index futures bottomed at 1802.50 and the April Crude Oil futures bottomed at $28.21. Based on this analysis, a rally to $40 in Crude Oil may very well send the index back to its all time high. The reasons being twofold for this scenario. First of all, energy companies such Exxon Mobil

and Chevron Corporation

are a few of the top constituents of the S&P 500 index and their rebound is highly correlated with the price of Crude oil. Just as Exxon Mobil swooned from its all time high from July 2014 ($104.76) to its August low ($66.55), so did Crude Oil. Although it July 2014 peak ($115.71) correlates perfectly to Exxon Mobil all time high, the low in Crude Oil is more muddled. The August 25 Flash Crash low in Exxon Mobil was an artificially low (due to extraordinary market conditions on that day).. Meanwhile, Crude Oil has continued to decline based on the fundamentals of supply and demand. Also, a barrel of Crude Oil does not pay a dividend and there are costs associated with storage. On the other hand, Exxon Mobil has a dividend yield of 3.56 percent along with the chance of principle appreciation. Simply stated, savvy long-term investors,, such as Warren Buffett, are getting PAID to wait out the decline in Crude Oil. The second and just as important reason why the market may explode to the upside if Crude Oil rallies to $40 is the boost it will give to many of the financials. As the index has come off its February lows with a vengeance, there was one major laggard, the financials. While the S&P 500 index has rallied over 8 percent from its February 12 low, many of the financials have been slow to respond. For example, Goldman Sachs low for the move stands at $139.05 from February 11. On Wednesday, it came down to $140.26 and has staged a significant rebound. What did its rebound correlate to, a rebound in Crude Oil. Obviously, investors have been shying away from financials fearing distressed debt held by the banks for energy companies may be an unlimited liability. Surely, investors that caught holding financials during the mortgage crisis in 2008-2009, were not going to get burned again. As is stands right now, many of the large banks have taken substantial write-offs for funds linked to the energy sector. Just imagine how those writeoffs would escalate if Crude Oil goes to $20 or below. For those of you who dismiss this thesis as hogwash, just take a look at the price action in the S&P 500 index and Crude Oil futures in Friday's session. Discounting the premarket high in the index (1968.75), the high made off the open (1961), corresponds to the high for the day in Crude Oil ($34.69) at 9:21 AM. What did the index do off the open? It retreated before finding support just above the premarket low (1948), only reaching 1949.25 at 10:26 AM. What did Crude Oil during this time period? It retreated from the highs and made its intraday low at $33.36 at 10:26 AM. Since making the corresponding lows, the index rallied to 1959 and Crude rallied to $33.89. Now at 11:30, Crude Oil has begun to fade and you guessed it, so has the index. The overall correlation between Crude Oil and the index in the short-term is undeniable. It is certainly may not be sustainable in the long-term, but for the short-term the charts speak for themselves. Even though a rally to $40 is hardly a significant rebound considering it is a small fraction of its nearly $90 slide, the implications for the markets are apparent. Just as the theory works for the upside potential for the market, a slide to $20 Crude Oil will have same impact for the downside potential for index. So when the following the market long-term or an intraday basis, keep one on your equities, but keep your other eye on Crude Oil.