Has Oil Driven Down the U.S. Equity Market?

February 19, 2016

Given the recent drops in oil and U.S. equity prices, many have concluded that the significant decline in oil prices has driven down the stock market. Indeed, from the onset of oil’s sharp dip, correlation between the two daily returns has greatly increased to about 45% on a 6-month rolling basis. Our chart this week examines if the correlation between oil prices and the equity market has always been so significant.

Going back to 1984, we graph the correlation between oil prices and the U.S. equity market (represented by the S&P 500 index) against the price of oil. Over this longer time period, it is quite apparent that the correlation is fluid, changing significantly across different time periods. Over the entire time period, the correlation averages only 7.7%. Certainly, in times of oil price volatility, correlation tends to rise between oil prices and stock markets, but it is not consistent over time and thus not a reliable indicator of future stock market direction. Though correlation does not imply causality, oil’s apparent influence on investors’ nerves, and consequently the market, may be a temporary indicator of market sentiment.