Oil/DJIA Correlation Stronger Than Ever

Source:

"First time daily oil, DJIA moves are positively interdependent."

Since late 2008, the daily correlation between WTI crude oil and the Dow Jones Industrial Average is the strongest it's ever been.

To compute the relationship between the two variables, I used the Pearson correlation coefficient (r). "Pearson's r," as it is otherwise known, ranges from -1 to +1. A value close to -1 indicates a strong inverse relationship, while a value close to +1 indicates a strong positive relationship. A reading close to 0, on the other hand, means that the two variables are weakly correlated.

Starting from January of 1986, I applied the correlation coefficient to the daily log return values of the two variables. Plotted below are the 50-day and 100-day correlation graphs:

WTI vs. DJIA (50-day): 1986 - 2010

WTI vs. DJIA (100-day): 1986 - 2010

As you can see, in late 2008, Pearson's r begins to significantly deviate from the normal trend of weak correlation. Ever since, it has held steady in strong positive territory. This marks the third instance, dating back to 1986, where correlation has been at least moderately strong. This is the first time, however, that the day-to-day movements of oil and the DJIA are positively interdependent.

What gives?

It was not until Lehman's bankruptcy in mid September of 2008 that the two variables started to positively correlate. Since then, it seems that oil speculators have been closely watching the U.S. stock market as a key barometer of economic health. And, until there is clear indication of global economic stability, we should expect this correlation to last.

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