Oil and stock prices moving in tandem since financial crisis erupted

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“The correlation between the prices of crude oil and U.S. stocks has typically been about 0.50,” said Mark Tepper, managing partner of Strategic Wealth Partners in Seven Hills, Ohio. “Since the summer of 2008, that correlation has been much higher and positive.”

Tepper believes that stocks have tracked oil because investors regard rising energy prices as a sign of increased demand (i.e., a strengthening global economy). Conversely, falling energy prices suggest lower demand and a weakening global economy.

Thus, in the current climate, expensive oil is a good sign for nearly everybody; cheap oil is a negative.

Further complicating this discussion is, of course, the U.S. dollar.

Historically, oil and the dollar have had a strong inverse relationship (with some exceptions). However, since July 2008, as oil prices have plunged, the dollar index has increased only modestly (not nearly as much as one would expect given the magnitude of oil's decline).

How might this positive correlation between oil and stock prices be broken?

Tepper believes a period of high inflation might do the trick.

“If we entered a period of high inflation in the U.S. due to either quantitative easing or just a general lack of confidence in the dollar, oil prices would climb,” he said.
“Consequently, people would have less discretionary income to spend and companies' cost of running their operations would rise, leading to reduced corporation profits – leading ultimately to falling equity prices.”

But that is unlikely to happen, at least in the near-term, as inflation remains quite subdued in the U.S.

“The financial crisis we have seen the past two years has been like one of those once-in-a-hundred-year floods,” Tepper noted.

“It has changed some of our assumptions about the financial markets. In the past when U.S. equity markets declined, one could find pockets of growth in certain foreign countries. But in the recent downturn, the crisis spread to all corners of the world, it was like the entire global economy declines at once. It was unprecedented and quite extreme.”

Tepper is currently bearish on oil and expects it to trade range-bound for the near-term, particularly given the lack of tangible signs of a global economic recovery.

“We forecast no significant appreciation in oil prices, but neither do we see any substantial drops in price,” he said.
Oil is presently trading at about $73 per barrel -- Tepper thinks its fair value price is about $80, so it is trading at quite a discount. But that may not portend a rise in energy prices since there exists so much pessimism about the health of global economy (and, hence, oil demand).

Mark Arbeter, chief technical strategist at Standard & Poor's, believes that oil prices will be stuck in a wide range for many years to come.

“Oil is working off the bubble that developed in 2008 and then the subsequent bear market into the lows in 2009,” he said.
“Many times after a bubble, a market will drift sideways for many years. Some of the latest examples include the NASDAQ and the housing stocks. I think we could see crude trade in the $60 to $90/barrel for the foreseeable future.”

If indeed oil remains range-bound over a multi-year period, it is reasonable to assume that stocks might also go nowhere for a while.