By Bruce Zaro

Sniffing the Wind — Strong Scent of Retreating Crude Over-Powers Stale Smell of Bear

Oil: A Slip, A Dip or a Dive?

This isn’t the first dip in oil prices we’ve seen in recent months and weeks, but it could be real news…for oil and for the US stock market in general.

A chart comparison between the current downward trend and the sharp corrections of recent years (July 2006, October 2007, January 2008) shows one significant difference. In this decline, crude broke strong support at $131 and the trend line of $128 shortly afterwards—a trend line that has been the guard rail for crude oil prices since 2001. Yes, it’s been breached before, but crude always stomped the clutch, threw the tranny into overdrive and shot back up over the line. Not so now.

We saw a reserve down take place at $124 and a new potential support emerge at $121, but that wasn’t the limit of downward potential. Given this week’s action, last week’s reversal to $127 appears to have been a dead-cat bounce. Today’s slide below $120 tells us to expect another downward drop that could test the waters of the May lows. Remember the old days when crude oil prices were in the $109-111 range? I see this decline potentially making it back to the old neighborhood or even further, maybe takin’ a drive on old 95.

Oil’s Loss, Market’s Gain

Oil’s downward trend, coupled with US dollar firmness and the announcement that the Fed was feeling confident enough about the economy to keep its hands off interest rates for a moment, has added strength to US stocks.

What basis is there for saying that a drop in oil is sustenance for the market? Well, we can look back through our hindsight lenses and note that the July 11th peak in oil was followed closely by the selling climax on July 15th that I’ve written about. This is not only an interesting association, but one in which history is repeating itself.

Crude oil historically has had a negative correlation to the US stock market. From 1986 through June 30 2008, the distribution of down and up years, and even the cumulative returns, have been similar for oil prices and the S&P 500. However a close analysis of annual and quarterly data uncovers the interesting fact that S&P Index returns were far better when crude oil was posting negative returns than when oil posted positive returns.

In other words, historically speaking, when crude oil is up, equity performance can be good, bad or indifferent. But when crude oil is down…drum roll, please…stocks perform much better. Crude oil is down and we expect it to go lower. Does it seem the smell of bear in the air is getting fainter?