For most of this admittedly still young year, oil and the broad stock market have been moving in opposite directions. Crude futures (CL), even after a couple of down days, finished yesterday around 12% higher than they closed out the year, while the S&P 500 was about 6% lower than on December 31st, 2021. That is a big difference over just three weeks, so why is that happening and, more importantly, what does it mean?
There are a lot of reasons why those two markets might move in opposite directions for a while without it being particularly remarkable or significant. The obvious one is that crude pricing has a supply element to it, and supply dynamics can change for any number of reasons. There could be either worry about or the actuality of a temporary disruption to output in one geographic area due to war or natural disaster, say, or there could be an OPEC-like agreement to restrict crude output to influence price.
Both of those apply to some degree to the current situation, but neither fully explains the disparity.
Geopolitically, there is some nervousness about the Russian presence on the Ukrainian border but, as a Ukrainian friend pointed out to me the other day, Putin’s troops have been “amassing” on that border for around eight years now. That doesn’t mean that there won’t be a crisis this year, but it does put the chances of one coming soon into perspective. And, as I’m sure you are aware, OPEC+ has an agreement…
For most of this admittedly still young year, oil and the broad stock market have been moving in opposite directions. Crude futures (CL), even after a couple of down days, finished yesterday around 12% higher than they closed out the year, while the S&P 500 was about 6% lower than on December 31st, 2021. That is a big difference over just three weeks, so why is that happening and, more importantly, what does it mean?
There are a lot of reasons why those two markets might move in opposite directions for a while without it being particularly remarkable or significant. The obvious one is that crude pricing has a supply element to it, and supply dynamics can change for any number of reasons. There could be either worry about or the actuality of a temporary disruption to output in one geographic area due to war or natural disaster, say, or there could be an OPEC-like agreement to restrict crude output to influence price.
Both of those apply to some degree to the current situation, but neither fully explains the disparity.
Geopolitically, there is some nervousness about the Russian presence on the Ukrainian border but, as a Ukrainian friend pointed out to me the other day, Putin’s troops have been “amassing” on that border for around eight years now. That doesn’t mean that there won’t be a crisis this year, but it does put the chances of one coming soon into perspective. And, as I’m sure you are aware, OPEC+ has an agreement in place to limit output. Once again, though, that is nothing new, and we are now in the period when the restrictions are being systematically eased.
So, while there are supply-related bullish influences on oil, they are not a surprise and don’t explain such a sustained, strong move up in CL on their own. For that to happen, there has to be a positive outlook on demand, and that is where the disconnect between oil and stocks comes into sharp relief. Both markets are sensitive to economic conditions and growth prospects, so which is making the right read? Is the economic picture and outlook strong, meaning that oil has it right or weak, meaning that stock traders are making a better read?
The correct, if somewhat unsatisfying, answer to those question is “It depends”.
Primarily, it depends on your timeframe. Front end oil futures contracts, by definition, look no further than a month out. Because of that, crude is being less influenced than stocks by what the Fed may or may not do later this year and, right now, the economy is strong. Unemployment is low and growth is decent. For stock traders and investors, though, even the thought of reversing the ultra-low interest rates that have done so much to create that situation and fuel the bull market is scary. For oil traders, it is something they will deal with when, and if, it comes. You cannot price something that will maybe happen in three to six months into a contract that expires in less than a month.
Still, the fact that longer-dated WTI contracts have kept pace with the front end on the way up suggests that the oil market is much more positive about the economy, both in the U.S. and globally, than are stock traders. History shows that when that kind of dichotomy exists, oil traders are right more often than not, in part due to that enforced short-term outlook in oil. Stocks are being driven lower by fear of what might happen; oil is being pushed higher by what actually is happening…and in my experience, reality beats fear most of the time.
So, as long as oil remains elevated, I will start nibbling at stocks on the way down. Most of that will be for long-term investment, but I will also look for some trades on the same basis. This morning, for example, I bought some S&P E-Mini futures (ES) at 4425. I am looking for a bounce-back above 4500 there and, if it comes, will set a stop just below 4450 with a target of regaining yesterday’s high of around 4600.
Given the intraday price action yesterday, that might not work out, I guess, but I like my chances. Cl bounced a couple of bucks off the overnight low of 82.78 this morning and, after initially looking like today would be another rout of stocks, ES has followed and bounced too. That could well mean that stock traders are starting to look past their fear and understand the message being sent by other growth-sensitive markets. If that is the case, stocks are close to the bottom of their move down and a bounce is coming soon.
