Former U.S. Fed Chairman Ben Bernanke weighed in this week on a single from the more curious market developments in recent years: the growing correlation between stock and oil prices.
In a blog post, Bernanke noted the relationship forwards and backwards can be volatile, but, overall, it is more positive recently.
Bernanke stops working the relationship into different components. First, he brings up among the theories behind the move: that oil and stocks are moving on concerns over global growth.
This pans to a degree, since the correlation between stock prices and interest in oil is higher than the correlation for stock prices and oil overall.
“That’s consistent with the concept that when stock traders react to a change in oil prices, they are doing so not necessarily because the oil movement is consequential by itself, but because fluctuations in oil prices serve as indicators of underlying global demand and growth,” Bernanke said.
But that explanation doesn’t give us the entire picture, since the correlation between stocks and oil is positive beyond only the demand component. That led Bernanke to place forward a second theory.
“Another possible reason for the positive stocks-oil correlation is based on the observation that recent market moves have been combined with elevated volatility,” he said. “If investors retreat from commodities in addition to stocks in times of high uncertainty and risk aversion, then shocks to volatility may be another reason for that observed tendency of stocks and oil prices to move together.”
But he notes even that doesn’t fully account for the relationship.
Generally speaking, oil and stock values have a tendency to historically have little correlation. Lower oil prices tend to mean lower costs for many businesses outside the energy space, meaning that following a delay, lower oil prices should translate to higher stock values.
But as Bernanke and others have noted, oil prices and stocks have experienced an increasing correlation previously two decades, which has many market watchers rushing to describe what is going on.
Unfortunately, after bringing up a lot of good points concerning the changes which have brought the marketplace to where it is today, Bernanke admits there are several unexplained factors that make the correlation a bit of a mystery.
“There are many other explanations that may be investigated: for instance, the possibility that declines in oil prices, even when initially caused by higher supply, affect global financial conditions by damaging the creditworthiness of oil-producing companies or countries,” he said. “This topic is one really worth revisiting.”
