Interpreting Middle East Economic News and Analyzing Market Trends

Falling oil price is actually a bad sign for the stock market

It’s too early to celebrate the falling oil price.  While there are obvious benefits to a falling oil price, namely cheaper gas at the pump for those in the developed world, the correlation with the stock market should not be discounted.  According to a recent story from CNBC, Brent Crude, the main benchmark for oil, has dropped 18% since February this year and there are still signs of lower prices coming up.  The reasons given for this drop were sluggish demand from China, Europe and the US. 

 

The oil price drop is being celebrated as a win for Japan, which has been relying more and more on oil for its energy since the Fukushima disaster in 2011.  A lower oil price for Japan means lower import cost (better trade balance) and lower inflation numbers (which I don’t think Japan wants right now).  However, a closer look at how the price of oil has been behaving in relation to the stock market and you can see that there really is no cause for celebration.

 

 

Source: www.commoditycharts.com

 

Since the financial crisis in 2008, oil has been moving inline with the the S&P 500 index, or more like, the S&P 500 has been moving inline with oil.  The chart above goes back two years to give you better detail of what’s happening now.  As you can see, both were moving up and down together with varying degrees until February this year when oil began to drop.  The conclusion would be either oil and the S&P have decoupled and are now moving independently or that the S&P 500 is headed for a nice drop.

 

Source: futures.quote.com

 

Let’s go back to right before the financial crisis to see how they have been behaving (sorry about the small chart above).  As such, I’m more in the camp of believing that the S&P (as well as other indices) is headed for a comparable drop in the coming weeks and months.  The reasons for this drop are the same reasons for the drop in oil price; weak demand from developed countries as well as China.  The recoveries in these countries (if they even had one) has stalled and a falling oil price is one of the first signs.  A falling stock market is another sign.