Stocks are taking a cue from volatile oil prices, where traders are looking for signs of recession and other problems in the market, according to analysts.
Crude futures and stocks have been trading in tandem throughout much of the last few months in part because both markets are concerned about the same macro factors: rising U.S. interest rates, the ongoing U.S.-China trade dispute and signs of slowing global economic growth.
U.S. crude futures: 3-month performance
However, some strategists believe equities are actually following oil prices, which serve as a sort of recession barometer, since economic growth is closely tied to fuel demand. At the end of last year, the collapse in crude futures essentially amplified fears of Federal Reserve rate hikes, trade tensions and the pace of economic growth.
“Stocks were far less of a lead indicator and more of a concurrent indicator than they usually are,” said Julian Emanuel, head of equities and derivatives strategy at BTIG. “Oil really got caught in the same geopolitical uncertainty downdraft.”
Emanuel notes that stocks bottomed on Dec. 26 after U.S. crude hit a trough on Dec. 24. Since their intraday lows, benchmark oil prices are up about 22 percent, while the S&P 500 has bounced back about 10 percent.
“The price of oil is telling you there isn’t going to be a recession. It’s firming up. To me that’s the feed through loop into equities,” Emanuel said.
S&P 500: 3-month performance
Oil prices are likely to head higher in 2019, in part because Saudi Arabia has backstopped the market on the supply side with significant output cuts, says Francisco Blanch, head of global commodities and derivatives research at Bank of America Merrill Lynch.
But there is also now support on the demand side following commentary from Federal Reserve Chair Jerome Powell that the central bank will be patient with future interest rate increases.
“With a shift in Fed policy direction approaching, we see an oil ‘demand put’ being triggered within the forecasting horizon,” Blanch said in a research note on Friday.
“In other words, we think that the global recession fears priced into oil markets during the Christmas period were overblown and see the Fed acting preemptively to deter a major global economic deceleration.”