No. 1: If oil price goes up, stock prices will fall. This is because the cost of doing business will increase and stock prices must factor this to account for the drop in earnings. i.e. oil price and stock price are inversely related
No. 2: During an economic downturn, business and production slowed, and hence the demand for oil drops. i.e. oil price and stock price rise and fall in tandem.
Which is correct? 1 or 2? Or both are wrong?
Ken Fisher did an analysis on the correlation between oil and stock (S&P 500). From 1982 to 2005, the correlation coefficient is -0.11(0=no correlation, 1=positive correlation, -1=inverse relationship) which is close to no correlation at all. The R-squared figure becomes 0.01, which means that only 1% of stock price movement is affected by oil prices. It would be better off paying attention on the other 99%.
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And for the correlation between oil prices with Britain’s stocks (FTSE All-share), the correlation coefficient is -0.09, and R-squared is 0.01. Same case.
Oil prices compared to MSCI EAFE (global index), the correlation coefficient is 0.05, and R-squared is 0.00.
Some may say that there is a lag time before stock price reacts to oil prices. Ken Fisher has done the checks and he is sure no matter what time-lag you use, there is no correlation.
According to him, the high oil prices in the 1970s was largely due to President Ford declaring the Energy Policy and Conservation Act, which set the Strategic Petroleum Reserve at around 700 million barrels. The accumulation of this size will inevitably pushes the price of oil up. There were two emergency drawdown till now. 17 million barrels in 1991 Gulf War and 11 million barrels after Hurricane Katrina. The top up of 28 million barrels in the 2000s by President Bush has contributed to oil’s rising price.
So let’s divorce oil and stocks once and for all. Oil prices are affected by supply and demand. Stock prices are affected by many factors and oil is not one of them.