As Sure as the Sunrise

Some things you just don't question in life. The sun will rise in the East. Politicians will lie to you. Superman will save Lois Lane. Happens every time! These things so are consistent we generally don't question them over course of our lives—we just take them as fact.

Here's another one: oil prices affect stock prices. We see a form of this argument almost everyday, even in the most reputable financial periodicals. There is a belief out there that as oil goes, so do stocks. Let's look at a few recent headlines:

"Stocks were boosted…by a drop in oil prices…" The Wall Street Journal, Dec. 19th, 2006

"The Dow Industrials eased…hurt by oil's rally…" The Wall Street Journal, Dec. 21st, 2006

"The Dow Industrials fell…despite lower crude prices." The Wall Street Journal, December 9th, 2006

"The Dow set another record…despite an increase in oil prices." The Wall Street Journal, December 28th, 2006

These were all printed within a few weeks of each other. Clearly, there's a bias that when oil is up, stocks should go down; and when oil is down stocks should go up. Anything else is an anomaly. This is the contemporary conventional wisdom, and people accept it without batting an eyelash.

But is it true? No.

For starters, stocks have done just fine in recent years as oil prices rocketed upward.

And if we have a look at individual trading sessions for 2006 for the S&P 500, there's no clear correlation whatsoever between oil and stock returns.

2006 S&P 500 Up S&P 500 Down
Oil Prices Up 70 days 60 days
Oil Prices Down 70 days 51 days

That's a pretty even distribution. If you're trying to account for the reasons the S&P 500 was up on a certain day, oil prices would provide you with exactly zero information—other than the fact that oil makes no difference.

The factors determining stock prices and oil prices are different. Both have separate fundamentals affecting their supply and demand. And the logic that high oil prices squeezes consumers and corporations, thus weakening the economy, just doesn't play out either. Corporate earnings, consumer spending, consumer net worth, and overall economic growth have all been robust as oil prices gained in recent years.

The sun will rise in the east tomorrow, but oil and stocks could do a number of things.