The Complex Dance Of Oil And Equities

The Complex Dance Of Oil And Equities

With stocks at all-time highs and crude oil at six-year lows, it can be unclear why analysts keep saying that the drop in oil prices is weighing down stocks.  

The Complex Dance Of Oil And Equities
The Complex Dance Of Oil And Equities

Try taking the price charts of the last 3 months in any of the stock indices and in crude oil futures and put one above the other. They look like mirror images.

You can create a chart grid, by the way, in the Nadex demo platform and it’s a good idea. Having a grid of charts on your screen lets you see the larger patterns in the global economy that may be affecting not just the markets you’re trading, but others that don’t seem related.

Some markets have straightforward relationships
All of the grains will have similar-looking charts, for example, during certain seasons. But when the price of, say, corn gets too low, farmers start looking for more lucrative crops they can plant in the same field, like soybeans or cotton. The traders’ expression for this is simple: “When the price is too low, the farmers say no.”

Sometimes the connections are not so simple. One reason the drop in crude affected stocks is that the energy sector comprises about 10% of the S&P 500 and lower oil prices mean lower earnings. The earnings reporting season has now wound down, but it was a big factor in recent weeks. That’s also a pretty simple connection to see.

Sometimes, it’s complicated
A little more complicated is the Saudi push to drive oil prices down by continuing to pump more even into a worldwide supply glut. The glut that people are talking about is real and unprecedented. The US strategic petroleum reserve, which was increased after 9/11, is close to capacity and may get filled to the max this year. Oil tankers are being used, not for transport, but as offshore storage tanks in ports around the globe.

The Saudis are pursuing a sort of Walmart strategy: beat their competitors in a price war until OPEC are (almost) the last ones standing and have a healthy market share. Today, Bloombergreports that the strategy appears to be working, with rig counts plummeting and some investment plans being rethought.  Transocean Ltd., the world’s largest offshore driller and also one of the most indebted, had its credit rating cut to junk by Moody’s.

And sometimes, it’s as complicated as, well, the Indian economy
This short term disruption to the oil markets has repercussions across most industries, but it butts up against the long-term benefits of lower energy costs, which are part of the overhead of every business and a hidden tax in most purchases. The effect can even be transformative for countries. In India, for example, the new government of Prime Minister Narendra is set to release its first budget tomorrow, with high hopes that it will signal a real reform agenda.

Reserve Bank of India governor (and University of Chicago prof on leave) Raghuram Rajan has kept interest rates high in order to curb India’s high inflation—a situation almost opposite to what Europe, Japan, and the US are facing. Even in such a different situation, cheaper oil is a net plus. India’s inflation is now coming down in part because of cheaper gas prices.

Meanwhile the stock market soars and GDP growth exceeds previous forecasts as individuals and companies have more cash to spend, again because of energy savings. It’s a great environment in which to introduce a new budget and a new economic framework, and it’s happening because India, which imports 75% of its oil, just saw its gas bill cut in half.

A big, oily web of humans and algorithmic computer programs
Lower energy costs are linked to phenomena as diverse as consumer confidence in Germany, Greece’s ability to handle its debt restructuring, and the ability of Indonesia and other countries’ governments to reduce fuel subsidies. It also raises worries about more carbon pollution or reduced interest in electric cars. The latter is probably not a real worry. People buy electric vehicles for other reasons.

One difference traders are seeing between stock index futures (and stocks) and the crude oil futures is the extremely low volume in the indices, something we wrote about earlier this week. Part of the drop is due to the drop in algorithmic trading in the index futures. Algorithmic trading programs need a certain amount of human-generated buy and sell stops to be triggered. Those have not been available in the S&P futures, but there is ample volume in crude oil lately. So that’s where the algos have gone to feed. While stocks meander sideways near all-time highs, crude is volatile.

Both types of markets offer opportunities for Nadex binary option traders. Because you only need to be a little bit right to get the full payout at expiration, even markets that aren’t trending (like stock indices) can be traded. And if the volatility in crude is keeping you from risking an outright futures trade, your risk in a binary is capped and set at an amount you choose at entry.

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