Simons: Will Crude Grease the Market?

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Experience is a great teacher if you are good at forgetting things. I can recall the crude oil price crash of December 1985 to February 1986 and how bonds traded tick-for-tick with crude oil, and then how stocks traded tick-for-tick with bonds. A little over a year later, we changed the chain of causation from the yen to bonds to stocks.

Now the yen is good for a few laughs every year when the 13-year-old yen carry trade, last visited here in September 2007, gets unwound globally in a two-minute period, and bonds pretty much ignore crude oil, and stocks and bonds more often than not trade inversely. If old dogs refuse to learn new tricks, their owners stop taking them to the vet's.

So imagine my amusement when the Ritalin-for-lunch bunch starts hyperventilating about how lower crude oil prices -- and that's "lower" in a very relative term; the present price level would have been shockingly high even eight months ago -- will pull this market higher single-handedly.

Shocks for the Long Term

First, let's stipulate the obvious: Stocks and crude oil have been correlated negatively over the past year. The operative part of that sentence is, "over the past year." Let's take the long-term history of crude oil and the S&P 500 and divide it along two very obvious fracture dates, May 6, 2003, when the Federal Reserve bravely began its war on deflation, and Aug. 17, 2007, when that war entered its surge phase.

S&P 500 and Crude Oil: Three Regimes Since 1983

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Source: Bloomberg

Three sets of ordered pairs emerge from that division and are mapped above. The January 1983-May 2003 period, marked in blue, has an essentially random relationship. The May 2003-August 2007 period, marked in red, has a strong positive relationship; both stocks and crude oil rose simultaneously under a combination of strong global growth and generally stimulative policies. The August 2007-August 2008 period, marked in green, has a negative relationship; stocks sank under the weight of the credit crunch while crude oil prices doubled.