Will Rallying Oil Set a Bear Trap?

The underperformance of hedge funds has cemented its place in the center of the myriad forces driving the market today. But in case you've forgotten, the price of oil has not gone away, and may be in the process of setting a very effective bear trap.

After the big run-up in equities from the May lows, the recent consolidation has been far shallower and more contained than many traders expected. I read this as confirming my prior view that there remains a large contingency of underinvested hedge funds (amongst others) that have become dip buyers.

Indeed, many hedgies are lagging this year. Those that got caught leaning the wrong way in the General Motors (GM - commentary - Cramer's Take) trade (long the bonds, short the stock) have unwound that position, so on top of some hefty losses, these funds are also sitting on healthy piles of cash.

At the same time, it is worth noting that mutual funds are running with bearishly low levels of cash on hand. While the latter could lead this sideways consolidation somewhat lower, it is the former that may keep this retracement well contained.

While this tension between the "too-much-cash" and the "not-enough-cash" on hand crowds play out, oil has crept back into the market discussion. The easy conclusion is that any increase in the price of crude is automatically bad for stocks, but the reality is far more complex. A quick look at some charts reveals that, at least for the past three years, there has been a positive correlation between the two assets. Since October 2002, oil has appreciated to $60 from $25 a barrel, a 140% gain. At the same time, Nasdaq has rallied to near 2100 from 1100, for a 90% gain. As far as stocks are concerned, so far, oil's bark is worse than its bite. To date, it has hardly been the Boogieman so many traders expected it to be.

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Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm's portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries, and is a member of the board of directors of Burst.com, a streaming media software company. At the time of publication, Ritholtz had no position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback; click here to send him an email.