S&P 500, Crude Oil, Energy ETFs, Global Growth – Talking Points:
- The coronavirus outbreak has had major impact on asset correlations
- Not all relationships turned positive: oil price and energy ETFs flipped
- S&P 500 outlook has increased in importance as traders eye global GDP
- Fundamental risks: more Covid-19, US-China & US-EU tensions, FOMC
One of the most prominent consequences of the coronavirus outbreak and its impact on financial markets has been a surge in correlation among assets. But sometimes the opposite can happen. In particular, I think that one of the most interesting shifts has been what seems to be a weakening relationship between certain energy exchange-traded funds (ETFs) and crude oil prices, at least for now.
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On the chart below is the Fidelity MSCI Energy Index ETF (Ticker: FENY) with WTI crude oil prices. The former is a financial instrument that represents the performance of the energy sector in the United States equity market. The two largest holdings in FENY’s portfolio are Exxon Mobil and Chevron, composing 23.77% and 20.79% of the basket respectively. It is also very similar to Vanguard’s Energy ETF (Ticker: VDE).
Prior to the outbreak of the coronavirus, crude oil and FENY tended to trade in unison. The 20-day rolling correlation stayed mostly positive. Correlation does not imply causation, but for companies like Chevron and Exxon Mobil, the price of energy is a key determinant of profits. After all, oil prices declining can shrink revenues. In this situation, their respective stocks tended to fall in value. When crude oil prices rose, they usually did too. Then came Covid-19.
In late March, FENY started to trade higher despite oil prices continuing to decline. In fact, the former climbed despite oil futures briefly dipping sub–zero in April. The two started trading higher again afterwards as energy prices recovered. However, as oil set higher highs in June, FENY diverged and instead set lower lows. What could explain this behavior?
FENY Versus WTI Crude Oil Prices
The Shift in Fundamental Dynamics
To help understand this change, let’s bring the S&P 500 into the picture. The US benchmark stock index is a frequent bellwether for gauging overall market mood. That is because economic conditions in the world’s largest economy can domino outwards. On the next chart below, the relationship between FENY and S&P 500 futures was not clear cut prior to the Covid-19 outbreak.
Then as financial markets collapsed globally, the correlation between the two quickly rose toward 1 and stayed elevated. Values closer to this number indicate a positive relationship. So even though crude oil prices were falling in April, FENY was rising alongside the S&P 500 as governments and central banks around the world embarked on aggressive efforts to stimulate growth.
As such, one could argue that the fundamental focus for energy sector ETFs shifted towards the broader outlook for global growth and overall liquidity conditions and away from the price of oil. This may be due to the importance of interim solutions to keep businesses running through the pandemic. According to Bloomberg, oil industry businesses got $1.9 billion in tax benefits from the CARES Act earlier this year.
FENY Versus S&P 500 Futures
S&P 500, Crude Oil, Energy ETFs Road Ahead
At some point in the future, one could argue that as the global economy recovers, the price of oil may become increasingly important for energy companies. For the time being, it seems that the focus instead could remain on general risk appetite. The Canadian Dollar is another example of a more-liquid asset that can at times follow crude oil prices, but see its fundamental dynamic shift around this market environment.
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So what is the road ahead for risk appetite? Virus cases in the United States have been worryingly rising as regions relaxed lockdown restrictions. Recent hotspots include Texas, California and Florida. The former’s governor recently halted new phases of economic reopening. An introduction of isolated lockdowns could derail bets on a swift recovery and perhaps discourage consumer spending.
Meanwhile tensions between the world’s largest economies – the US and China – over Hong Kong risk rising. This is as the United States could potentially pursue about US$ 3.1 billion tariffs against certain nations from the European Union. Next week, all eyes will turn to minutes from this month’s FOMC meeting. If cautious commentary about the growth outlook is reiterated, this could rekindle risk aversion.
S&P 500 Technical Analysis
From a technical standpoint, it could be argued that the S&P 500 remains in an uptrend. I have drawn new rising support on the daily chart below – red line. The 50-day simple moving average (SMA) is fast approaching and it could guide the index higher. Conversely, a daily close under the SMA (with confirmation) could open the door to a deeper reversal. Uptrend resumption entails a close above 3231.
Data provided by
of clients are net long.
of clients are net short.
S&P 500 Futures Daily Chart
— Written by Daniel Dubrovsky, Currency Analyst for DailyFX.com
To contact Daniel, use the comments section below or @ddubrovskyFX on Twitter