The direction of the crude oil market has been among the top factors that are deciding whether the markets will gain or lose. Here’s proof.
Earlier in the year, the US market was down as fears grew about oil companies going bankrupt due to low oil prices, thereby, hurting banks and the economy at large in the process.
The chart above backs the point above. And as the chart above shows, it wasn’t until crude oil started a rally that the S&P 500 started recovering, before very positive vibes from the economy out-powered the crude oil market to help the S&P 500 register a new all-time high in July.
There is a new story now. A disconnect between the price of crude oil price movement and the S&P 500 level movement is growing. While the positive vibes that economic data has been sending is a big part of that, there is a new factor: Oil companies as well as banks might have found a way to protect themselves from the oil market turmoil.
Here’s what we know about the signs that banks and oil companies might have found a way to protect themselves. The iShares iBoxx $ High Yid Corp Bond ETF (HYG) is one of the tools that analysts have been using to weigh the health of stakeholders that are in danger of an oil market downfall.
As oil prices kept falling last year, and hedging contracts expired, the HYG fund started singing to tune of the oil market, as the chart shows. Even when crude oil rallied earlier this year, the HYG also rallied. However, the correlation has also discontinued. And it is easy – and correct – to say that the positive economic vibes is the reason for that as well.
However, it is also because oil market stakeholders have been hedging against the downside. Here’s proof. In early July, Reuters reported that of the 30 largest US shale companies, 17 “increased their hedge in the first quarter of this year.
So in addition to the economic factor that has been causing the disconnect between the stock market and oil prices, the fact that the oil market stakeholders have been locking in sales at around $10 a barrel – well below current levels – has also been highly important.
Of course, it’s difficult to predict the future of oil, as there are many unpredictable variables that would go into such calculations. However, going by the US Energy Information Administration’s forecast of an average Brent price of $44 per barrel in 2016 and $52 in 2017, it is unlikely that oil prices would hit such a low level anytime soon – if ever.
Therefore, investors can expect that the disconnect between the price of crude oil and the stock market will continue for the foreseeable future. The only thing that could put the stock market drive back into the hands of the oil market is a weakening economy. Understanding these trends is just paramount to knowing how to choose the right assets to trade.