The Relationship Between Crude Oil Prices and the S&P 500

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Sewanee University of the South
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Historically there has been an inverse correlation between S&P 500 prices and crude oil, but in 2010 the economic recovery pushed the stock indexes up and the prices of crude oil, especially in the United States. In 2017, stock markets and oil prices have moved in unison, a rare coupling that highlights growing fears about the health of the global economy. The volatility of crude oil continues to cloud global stock markets. In a year and a half, Brent's barrel has lost two-thirds of its value. But traditionally, what is the relationship between these two values? Variations in the price of oil have substantial effects on the economy, but in the case of the stock market they often operate in opposite directions or affect actors who are too different from the stock market (Jones and Kaul 2012, p. 92). Changes are often more circumstantial than applicable to theory.

When crude oil prices increase, the value of S&P 500 rises as well and this may be due to the influence of various economic variables. The relationship between crude oil prices and S&P 500, in general, has been widely analyzed and tested by authors such as Killain (2005, p. 215) , Lee et al. (2009, p.40), and Masih (2008, p.86) . Lee et al. (2009, p. 42) point out that a reduction in the prices of crude oil has negative consequences for S&P 500 prices, such as volatility spillovers and reduced earnings expectations. Barsky and Killiam (2013, p.116) argue that the future trajectory of S&P 500 prices is uncertain given the close relationship between energy prices and non- energy sources. More specifically, this relationship has become more intense with the recent boom, with financial experts claiming it could be because of the softening of the global aggregate demand which has decreased corporate profits and oil demand. Bermanke et al. (2013, p.120) established that fluctuations in the prices of crude oil had an impact on not only S&P 500 but the entire stock market and a decline in the economy as well. The recent strong relationship between oil prices and equities resembles the view during the economic recession and recovery in 2008-2010 (Park and Ratti 2008, p.78). This contrasts with a weak correlation between oil prices and stocks in the years before 2008 and also with price movements that year when oil and equity markets decoupled.

Many authors have suggested that the increasing presence of speculators in the crude oil markets could explain the peak in prices in the 2007-2008 period (Masters 2008, p.88; Du, Yu and Hayes 2011, p.113). And this is why the debate has taken place on whether or not there is a "bubble" in the stock markets and the S&P 500. Authors like Irwin, Sanders, and Merrin (2009, p.11) find little evidence that the recent boom in the prices of stocks and shares has increased the prices of oil. For them, the fundamental variables provide a better explanation and the factors that influence the prices of the energy markets.

Other authors suggest that the peak in prices in 2007-2008, still largely due to the increase in global demand, can not only be explained by macroeconomic factors and that speculation must also be included in the analysis (Kaufmann and Ulman 2009, p.24; Kaufmann 2011, p. 56). In addition to the factors already explained, the relationship between crude oil prices and the price of S&P 500 is considered close. However, the direction of causality among these variables is not clear and has been widely debated. For example, Chen et al. (2010, p. 111) shows how crude oil prices have predictive power of S&P 500 values. However, other authors find empirical evidence that oil prices and S&P 500 rates respond to changes in commodity prices. More specifically, Ferraro, Rogoff, and Rossi (2012, p. 87) explain how changes in oil prices have a significant influence on the S&P 500, arguing that low oil prices hurt the S&P 500 value. In this line is also the work of Basher, Haug, and Sadorsky (2012, p.67), in which they support the hypothesis that a decrease in oil prices lowers the S&P 500 value. This topic of econometric analysis of S&P 500 prices and energy markets has been deeply debated with findings in some cases showing correlations between the two variables (Natanelov et al. 2011, p. 56).

In September 2008, the financial crisis broke out. The stock markets began to sink, the economies too became declined and logically the price of oil too as the demand for oil decreased drastically due to the global crisis. The correlation became positive. However, this is a correlation, not causality. In 2008, oil and the stock market fell apart,-because there was a crisis for both (fewer buyers). Beginning in 2012, S&P 500 began to recover, oil prices began to increase, and the correlation disappeared. In the summer of 2015 oil prices began to drop and the value of S&P 500 remained relatively unchanged. When oil prices collapsed in the first weeks of 2016, the world's major stock indexes recorded one of the worst starts of the year in history. Brent, the international market benchmark, fell by 5.2% to $ 30.50 a barrel while U.S crude CLc1 dropped 7.6% to $29.75 a barrel.

In the first weeks of December 2015, the barrel of crude Brent (reference oil for European countries) had fallen to its lowest levels since 2008. The floor of $ 36.20 that hit the price of oil on Christmas Eve that year marked a historical limit to which many oil-producing countries looked suspiciously (Apergis and Miller 2009, p.88). Volatility had hit this market for the second time in the financial crisis. Traditionally, declines in oil prices have been welcomed on the Stock Exchange. It is historically attributed a certain negative correlation to the two concepts: if the crude oil is cheap, the companies, in general, react favorably and, if on the contrary, the prices rise, most of the companies adjust the increase of costs to its expected benefits and, consequently, its price (Hamilton 2015, p.76). But since the outbreak of the financial crisis, the opposite has happened: there is a constant parallel between the price of oil and the movements of the markets.

Recent literature on this topic has focused on possible relationships between oil prices and S&P 500. Nazlioglu and Soytas (2012, p 23) examine the relationship between world oil prices and S&P 500 values between 2005 to February 2010. Their results show strong evidence of the impact of oil prices on S&P 500. Researchers have also focused in recent years on a specific class of commodities, biofuels, and the possible effects between these and the stock markets. Natanelov et al. (2011, p.56) show a lack of co integration between S&P 500 and crude oil between mid-2004 and July 2006, which is caused by political interventions in crude oil. MNV (201, p. 6) analyzes futures prices for four energy commodities (crude oil, heating oil, gasoline and natural gas) and stock prices for the period 1986-2010 in the North American market. Using multivariate GARCH models, DCC conclude that the S&P 500 stock index and the exchange rates are significantly affected by changes in oil prices. However, for them, financial speculation is scarcely relevant in modeling these commodities. Also, they detect an interaction between the prices of the same.

Apergis and Miller (2009, p.34) conclude that there is a weak cause-and-effect relationship between the two, among many reasons, because of the complexity of the movements between the two concepts. Barsky et al. (2013, p.88) deny the existence of any correlation at present. It is hard to establish a concrete relationship at present, for many reasons: the efficiency of using the crude oil consumed is much higher than it was for other decades, and therefore the impact of variations in its theoretically lower price and the stock indices coexist with companies whose relationship with oil varies enormously.

The truth is that empirical evidence shows a weak cause-and-effect relationship between the two, among many reasons, because of the complexity of the movements between the two variables. Some studies observe a greater relationship in cases of price rise than in the fall (as a sign of overall demand growth and investor confidence). Others deny the existence of any correlation at present. It is hard to establish a concrete relationship at present, for two main reasons: the efficiency of using the crude oil consumed is much higher than it was for other decades, and therefore the impact of variations is theoretically lower and secondly, the stock indices coexist with companies whose relationship with oil varies enormously.



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