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@ The Corner – Can Oil Down, Stocks Down – Become Oil Up, Stocks Down?

By: Ken Reinhart

An old adage in market analytics states correlation does not equal causation.  All-too-often it is easy to see two broad based themes develop simultaneously, and in a general observation, believe one is creating the other.  One broad based observation of late that seems to have entered the collective thinking is that the oil downtrend has equaled the stock market downtrend.  With this, these two themes seemingly have become intertwined.

Oil market down –  stock market down –  long enough, can turn into a belief of oil market up –  market all good again.  Maybe not.  This correlation does hold up when looking at certain industry groups, and some inter-market interactions whereby down trending oil does play an obvious role in negative performance.  As a broad based statement for the market as a whole – there is a larger story.

An on-going weak global economy is a common thread both share together.  Reversing or stemming an oil price slide does not equal – fixed global economy.  Right here is where broad based stock markets can continue to have problems even if oil does not see a new low anytime soon.  Output cuts and freezes, resulting in higher prices to a commodity market such as oil, does not right the ship of the global economy.  In fact it could cause deeper issues depending on the price rise and its trend.

An interesting angle in recent times from some market analysts has been to create views known as “ex-oil.”  For example, they may take the S&P 500 companies collective earnings and subtract out of it the oil related component companies because their profits have been negatively affected in light of the oil drop.

For my part, what is lost in this approach (as well as other “ex-oil” approaches) is the reality that the other non oil companies in the S&P 500 have benefitted (in some cases tremendously) via lower operating expenses.  In addition to this, they have also benefited from increased sales they may not have otherwise seen if the consumer had not experienced a reduction in their “operating expenses” – think increased discretionary income via an energy “tax cut.”  The point being, it is not easy to just extract out the obvious negative without also realizing and accounting for the simultaneous positives it has on the economic system.  Specific to the stock market, via the S&P 500, there have been positive experiences for said companies as a whole with the energy drop.

Global economic issues has left in its wake an on-going multi-quarter sales and profit growth challenge of corporations collectively.  When we are talking about the stock market as a whole, we are talking about corporations collectively.   Sales and profit growth rates have been challenged for the bulk of 2015 and continues to current day.

Adding an increased cost, via a higher oil price, to an already challenged economic system may not be the fix we collectively think it can be.  Just like the drop in energy costs acted as a pseudo tax cut, an increase in said cost can also act like a pseudo tax hike.  With this, those “ex-oil” analytics would disappear with improvement from oil related companies within the S&P 500 for example, but the improvement can be negated and then some with the negative impact via higher operating expenses of both companies and consumers alike.

This process could break this collective view:   Correlation equals causation of –  oil down/market down and become oil up/market down.

We will leave that to the market to figure out and it will inform us with each trading day – on a trend basis.  Thus far the trend is down and the recent upturn would be considered a counter-trend rally – as in moving higher against its primary trend of being down.

If the market changes its primary trend we will be changing with it in the form of a more aggressive stance with portfolio positions.  For now, we watch and remain cautious realizing the correlation of oil down/market down can become what’s known as inversely correlated of oil up/market down.  This is not a prediction, it is merely a thought offered as a possibility when looking at the backdrop of a weak global economy, and what a “tax hike,” via higher energy could end up producing.

Ken Reinhart

Director, Market Research & Portfolio Analysis

This commentary is presented only to provide perspectives on investment strategies and opportunities. The material contains opinions of the author, which are subject to markets change without notice. Statements concerning financial market trends are based on current market conditions which fluctuate. References to specific securities and issuers are for descriptive purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. There is no guarantee that any investment strategy will work under all market conditions. Each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. PERFORMANCE IS NOT GUARANTEED AND LOSSES CAN OCCUR WITH ANY INVESTMENT STRATEGY.

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