VIX-SPX Correlation Testing Investors’ Psyche

The following screenshot depicts just how quickly the economic situation can change with an equity market near it’s top and as a major correction takes place, only to be followed by a V-shaped recovery.

Household net worth had the biggest one-quarter decline, outside of the great recession, followed by the biggest one-quarter jump, outside of the tech bubble.

This ain't your grandfather’s stock market folks.  If you’ve been disappointed that attempts at calling a top in the market rally or bottom in the recent pullback; don’t think you’re alone in that belief. Many market participants have failed with these predictions and analysis.

If there has been one chart or one set of correlated charts that identified greater probability of where equities are heading next it has been the Crude oil-S&P 500/DJIA charts. For this particular narrative, we’re going to utilize the Crude oil-DJIA correlation, given the relevance of oil and industrials.

Oil and stocks have been in a strong positive correlation since around the beginning of August 2018. But for the 5 months prior to that start point, they were in an inverse correlation. And they were in a positive correlation leading up to March 2018. 

In order to explain the relationship of equities to oil prices here is what Tom McClellan has to offer on the subject matter:

It makes sense in one respect that there should be an inverse relationship.  After all, higher oil prices are inflationary, and that could lead the Federal Reserve to hike short-term interest rates, potentially harming the stock market.  Higher oil prices also impact the corporate earnings of companies, which use petroleum products to make or ship things (although having higher oil prices helps the companies selling the oil).  High prices for oil leads to higher gasoline prices, which impacts the consumer’s ability to spend money on other things. 

A positive correlation makes sense when we realize that a lot of the high-yield debt out there has been issued by oil drillers and others in that industry, who might have trouble if oil prices fall too much.  Low oil could endanger those companies’ ability to make debt payments, which could lead to defaults, harming the banking sector, and soaking up liquidity that might be otherwise available to lift stock prices. 

What we can see from this most recent 1-month chart of Crude oil and the DJIA index is that over the last 30-day period, an inversion has commenced as crude oil prices have fallen while the DJIA has been relatively stable. 

Having said that, crude oil prices are falling sharply on Wednesday morning and finding U.S. equity futures under pressure for the first time in the last 7 trading sessions. Are the equity futures pressure due to crude oil prices falling or because of other extenuating factors related to anxieties over global trade feuds and weakening economic data remains an unknown. It’s for this unknown that it is likely a best consideration to tread cautiously and recognize that uncertainty has loomed large throughout the 2019 market rally, pullback and secondary rally. 

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