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Crude Oil Closes at a New High- Why This is Bearish for the Equity Markets

HedgeFundLIVE.com — Crude oil made a fresh 52 week on Friday, closing above 107.  The correlation between oil and the stock market is not that high so I will look at how the broader market tends to react when oil makes new 52 week highs to see whether the odds tell us anything.

Oil has been on a tear and so has the stock market.  As a testament to the fairly low correlation between the commodity and stocks, of the 213 times since 2000 that oil has hit new 52 week highs, slightly over a third of the time the S&P was up over the prior 10 days.  In other words, new 52 week highs imply that oil has been strong, but to see similar strength in the equity market is rare.  The 10d change for the S&P futures lies at 4.2%.  Historically, when oil printed new 52 week highs, the 10d change in the Spooz was over 4% merely four times.  Here is what happened in the next 5, 10, and 20 days for those four instances:

Next 5d Chg Next 10d Chg Next 20d Chg
0.77% 0.52% -0.91%
-0.35% -5.32% -8.09%
-0.16% -7.51% -8.06%
-3.87% -3.87% -5.42%

If those numbers don’t scream bearish to you, I don’t know what else would.  However, four data points is a very small data set to be working with.  Hence, I will decrease the 4% 10d change criteria by increments of 1%.  So when oil made new highs and the Spooz were up more than 3% over the prior 10 day period, the odds for the market being in the next 5, 10, and 20 days are as follows:

  5d Chg 10d Chg 20d Chg
ES 10D Chg 3.00%    
Next Time Period Pct Chg Input 0.00%    
Number of Instances 13    
Number of Up > 0% Over Next Time Period 5 6 7
Probability of Up >0% Over Next Time Period 38.46% 46.15% 53.85%

Again, bearish stats, particularly for the next 5 days.

When I decrease the ES 10d change to 2%, below are the odds:

  5d Chg 10d Chg 20d Chg
ES 10D Chg 2.00%    
Next Time Period Pct Chg Input 0.00%    
Number of Instances 35    
Number of Up > 0% Over Next Time Period 16 16 23
Probability of Up >0% Over Next Time Period 45.71% 45.71% 65.71%

Now the probablities finally tick up a bit.  But even then, the average and median returns paint a slightly bearish picture as they are negative for the next 5 and 10 days:

Next 5d Chg   Next 10d Chg   Next 20d Chg  
Average -0.79% Average -0.61% Average -0.06%
Median -0.35% Median -0.59% Median 0.35%
Max 3.56% Max 5.95% Max 9.55%
Min -4.37% Min -7.51% Min -8.09%
Conclusion: Given the low odds of the market moving higher following a new high in oil while the S&P E-Minis have been strong over the prior 10 days, I am expecting a pullback in the S&P for the next 10 days (2 weeks) or so.  I am particularly bearish for the next five days (this entire week).