Oil Is Down 20% From Its Recent Peak - That Typically Leads Stocks Lower

| About: SPDR Dow (DIA)

Summary

We have been expecting down oil for the last few weeks.

We recently showed how peaks in oil lead peaks in stocks.

That lead seems to be dropping further which reminds us that stocks also can go down.

We became bearish in oil July 11th. We recently showed how major peaks in oil have led to major peaks in the stock market. We have been bearish on stocks for some time and we don't see the follow through after the huge short squeeze post-Brexit. As we watch oil drop further we think the oil-market relationship will be in effect. The longest it has recently taken to drop markets is two months.

We showed this chart recently which shows how oil peaks lead stock market peaks (NYSEARCA:SPY).

Click to enlarge

The blue line is oil (NYSEARCA:USO)(NYSEARCA:OIL)(NYSEARCA:UWTI) and the red and green line is the S&P 500. You can see the white lines from the blue line to the S&P 500 above it are all leaning a little. None of those lines are perfectly vertical. They all lean to the right at least a touch. That says oil leads the market.

The more oil drops the more oil's peak looks very clear. The more that peak looks clear the more we expect this relationship to hold.

Why should oil lead the market?

Oil is a pure commodity more associated with pure quantities of supply and demand. While supply has picked up somewhat we've heard many global organizations come out since Brexit to say global demand is slowing.

Oil is sensitive to that demand more quickly than the stock market. Why? Economics take effect almost immediately on a commodity. Less people that demand oil the lower the price responds in open markets.

While the stock market has many factors that get people to want to buy or sell, oil has mostly just two supply and demand. When demand is not matching the supply the price drops.

The Fed Gets Hawkish In A Slowing Globe

Oil is showing us the precarious position we are in. The Fed is worried about inflation but the world's demand is slowing. We think the combination is a negative market setup because a rate hike or hawkish tones would further slow global growth.

US inventories were reported up today.

As another disconnect between the Fed and demand, oil inventories showed an uptick in the US today.

Here's the chart that represents US inventories. You can see that seasonally inventories are supposed to drop at this time in the summer. The fact that they are up is a sign that demand may be slower.

If demand is slower than expected there would be less energy usage. This would show up in higher inventories in a period that is typically expected to draw on inventories.

While the world is slowing GDP-wise the US may be showing signs of slowing as well.

Here's US GDP which is also slowing.

Click to enlarge

So oil and inventories are a gauge of demand. GDP is demand. You see above that GDP (demand) has been slowing.

We think that's why you have a real time indicator in oil to tell you where the stock market can go. Oil shows you demand which will ultimately show up in the stock market.

Conclusion

Oil continues to drop. From its high to now is a drop of 20% since June 9th. We've shown that the longest a peak of oil takes to predict a peak in stocks is a little over two months. We think oil is a real time demand indicator. We expect that to show up in stock prices. What further complicates this setup negatively is that the Fed is getting more hawkish while it appears demand in the US and abroad is slowing.

We're bearish on stocks and oil.

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Disclosure: I am/we are short SPY, BUT THAT CAN CHANGE AT ANY TIME.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.