Oil and stocks seesaw: Fisher's financial mythbusters

Some bunk goes in and out of style. This one was red-hot, but you don't hear about it much lately. It will be back - probably the next time oil prices rise a lot.

The fairly universal belief is that high oil prices are bad for stocks. When oil is up, stocks go down - they're negatively correlated. But it's bunk. Long term, they mean nothing to each other and one isn't predictive for the other.

The thinking is fairly intuitive and goes: a higher oil price makes life more expensive, which slows the economy and means lower earnings and profits for firms, as money gets sucked away from them and into our petrol tanks - so it's ultimately bad for stocks.

A POUND SPENT IS A POUND SPENT

Think globally, however, and this seems silly - even before checking history. See it this way: a pound spent in the global economy is a pound spent. If you spend £100 a month, the global economy doesn't care if it's on petrol, tennis shoes, tax advice or pet rocks.

If you spend £30 on petrol and £70 on everything else, that's £100. But if petrol rises, costing you £40, you have just £60 for everything else, except it's still £100 spent. Maybe oil firms profit marginally more and other firms less. Maybe not.

Maybe oil prices are being driven higher by transport costs resulting from huge demand for other gadgets. Or maybe those other firms instead gain via innovation, cost cuts or something else giving them more - it happens all the time. Capitalism is awesomely adaptive!

People fear higher oil stalls the economy and dings stocks, so when oil goes up, stocks go down. And lower oil means they have more money to spend (they think), so that's supposedly better for stocks. But history contradicts that.

Sometimes the two are negatively correlated. Sometimes they're uncorrelated. But over long periods? There is nothing there.

MEANINGLESS

Figure 1 (below, click to enlarge) shows monthly returns for both US stocks and oil. The correlation co-efficient is a number between +1 and -1 that shows how much two variables move together.

The higher the number, the more positively correlated they are - zigging together at the same time and to the same degree.

A number close to -1 means they're negatively correlated - they zigzag the way the myth presumes oil and stocks do. A number close to zero means the two have no relation - one zigs and the other broccolis.

oil-price-and-stock-market-correlation

Since 1980, the correlation between oil and US stocks is 0.03. Meaningless - the two aren't related in the long term at all (by the way, you can do the same thing with oil and UK, German, Japanese, and world stocks, and get the same meaningful lack of correlation).

Now look at the R-squared, which tells us how much of one variable's movement can be explained by the other. Here, it's 0 per cent. Said another way, over long periods, anything and everything but oil contributes to the stock market's movement.

Can oil prices impact certain industries and firms more directly? Sure! Energy firms for a start, particularly if they're drilling, refining, and/or selling oil or oil products. But overall, oil and stocks aren't correlated - positively or negatively.

That's longer term. Over shorter periods, oil and stocks can have short spurts of intense positive or negative correlation. But any two bizarre variables can inexplicably move together (or oppositely) for short spurts. It means nothing.

PURE RANDOMNESS

Figure 2 (below, click to enlarge) shows 12-month rolling correlations between oil and stocks - sharp, jagged, short-lived spikes up and down. Above the line means they're positively correlated, below means negatively.

There was a longish period of varying degrees of negative correlation from 1987 through to 1992, but even then it was wildly variable. Other than that, there's no predictability evident except for the pure randomness.

oil-price-twelve-month-correlation

The fact is, oil prices are determined by supply and demand, the same as stocks. Sometimes, higher prices reflect higher demand driven by a growing economy. Then, it would be perfectly normal to see oil and stocks rising together.

Or oil might be spiking because of supply disruption, which might not be great for the economy or stocks - so they could zigzag. Or maybe the disruption is short term in nature, and stocks know it, so they do whatever they were going to do regardless.

Often, oil and stocks move together when the economy is suddenly stronger than expected, which is good for stocks and causes unexpected economic demand that ripples to energy usage.

And sometimes the reverse occurs. But knowing where oil is going won't tell you where stocks are headed.

Oil and stocks have completely separate supply and demand drivers. Some overlap, many don't. Our economy is intensely complex - there are no iron-clad 'when X is up, sell stocks, and when X is down, buy stocks' rules that work long term.

Ken Fisher is founder and chief executive of Fisher Investments.

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