Business

Why stocks and oil are moving in lockstep

The sharemarket and the price of oil are moving hand in hand, indicating concerns run deep about the effects persistent low energy prices are having on an already low-growth global economy, market strategists say.  

The US S&P 500 index has been tightly correlated with Brent crude oil prices since December when the commodity dropped below $US40 a barrel, Australian Stock Report head of research Chris Conway said.  

Since then, the correlation between the price of oil and the sharemarket has skyrocketed to more than 90 per cent, not seen since the global financial crisis and well above the 20-year average of 25 per cent. 

The Australian sharemarket has duly followed Wall Street's footsteps, albeit with distractions from China's currency and sharemarket movements during the past month.

The biggest reason investors are linking oil's fortunes with equities is the threat of deflation from the low cost of oil, with developed and emerging markets alike struggling with disinflationary pressures, Mr Conway said. 

"If deflation hits global markets we're in a load of trouble, both from a financial markets and economic standpoint," he said. 

Advertisement

But investors were equally not willing to wait the 12-to-24-month lag time it took for the lower prices to boost the economy through consumption, he said. 

Other reasons keeping the pair instep include the pressure on oil producers to sell assets accumulated in sovereign wealth funds, Capital Economics chief economist Julian Jessop said. 

"[But] this selling might actually boost the global economy if the proceeds are used to support local spending," he noted.

The tumbling oil price is also breeding pessimism in oil producing nations, with history suggesting falling commodity prices are the biggest cause of sovereign defaults among emerging markets. Officials from the International Monetary Fund and World Bank are meeting in Azerbaijan to discuss a $5.7 billion emergency loan package for beleaguered nations. 

Also weighing on sentiment was the stress the oil market is having in the high-yield bond market and in emerging markets, UBS equity strategist David Cassidy said.  

The spread between high-yielding, or "junk" energy bonds and safe-haven US Treasuries hit its widest spread this month amid the collapsing oil price, spurring concerns of a bubble-over into credit markets. 

"There should be winners and losers, the stress seems to be outweighing the benefits at the moment," he said. 

A bottoming out and sustainable rise in oil prices could be the catalyst to break the correlation.

"I think equities would react positively to a rebound, to a degree," he said. 

Kay Van Petersen, Saxo Capital Markets Asia macro strategist, said there was no one factor doing the damage. 

"In situations such as this ... it's the accumulation of cracks in the building that are affecting the infrastructure," he said. 

But he warned the market will see some "dead bodies" in the energy and commodities space before the worst was over. 

Capital Economics chief economist for Australia Paul Dales said the reasons behind the fear were unlikely to hold up in the long term. 

"A global deflationary spiral is not going to happen when more economies are still growing," he said. 

"We expect a lot of these concerns will blow over as the incoming economic news improves, even in China, and the oil price rebounds as demand fears fade and supply is cut." 

Mr Van Petersen said long-term investors should treat it as "simply noise".

"At any one time in the market there is a main driver that people focus on, rightly or wrongly. At the moment it's all about oil." 

The correlation mattered to tactical and near-term traders, however.

"If you get oil right, there is currently a higher chance of you getting the S&P and risk on/risk off moves right," he said. 

Advertisement