What's the market message from the surge in crude oil

Key points:

• Crude oil has surged 68% above its 36-month moving average as of 2/28/22
• Similar spikes suggest stocks could struggle
• We should also be more attentive to slowing economic conditions

Does a surge in crude oil provide a market message

Crude oil and other commodities have been in solid uptrends for some time now. The Russia/Ukraine conflict has impacted near-term price action, causing massive spikes in several markets like energy, metals, and grains. As of 2/28/22, crude oil traded 68% above its 36-month moving average. If we look at the intra-month spread above the average, my data shows 90% as of 3/3/22.

I conducted an optimization process with monthly data, which has more history, to identify what level above the 36-month moving average impacted stocks. The study showed a cross above 66% as the level at which the S&P 500 struggled the most. Let's review the outlook for stocks after similar surges in crude oil.

Several surges in crude oil have coincided with bear market periods for stocks.

Similar surges in crude oil impacts the economy

Massive spikes in crude oil have typically preceded recessions since 1973. As a reminder, one should always use a weight-of-the-evidence approach versus relying upon a single indicator.

Similar signals show slightly weak to flat results

This signal triggered 6 other times over the past 49 years. After the others, S&P 500 future returns, win rates, and risk/reward profiles were underwhelming across all time frames. Stocks traded lower at some point in the first three months in all instances. While the sample size is small, there are some noteworthy signals. 

Sectors and industry group performance

Sector and industry group returns reflect the same underwhelming message as the S&P, with some notable standouts. In particular, the technology sector shows very weak performance trends across all time frames. Value-oriented sectors performed better than growth ones.

The consistency table highlights the same general trends. Value-oriented groups look much better than growth ones.

Crude shows weak performance trends

The spike in crude oil would suggest that we need to be mindful that prices could reverse lower, especially if the Russia/Ukraine situation ends abruptly. I would ignore the returns from the 1973 signal as it reflects monthly data, whereas the other signals use daily. i.e., it's a data constraint.

A bonus chart - Wheat futures reflect the near-term panic bid in certain commodities

Russia and Ukraine are responsible for a sizable chunk of global wheat production. The conflict is wreaking havoc on wheat prices and other grains, adding one more tax on consumers, ultimately impacting global economies.

What the research tells us...

When crude oil surges by a significant amount above its 36-month moving average, history suggests that stocks could struggle and that we need to be more alert to an economic slowdown. Similar signals to what we're seeing now have preceded slightly weak to flat returns for the S&P 500 across short and medium-term time frames. An assessment of sectors and industries shows a more favorable outcome for value-oriented groups. If the Russia/Ukraine conflict ends abruptly, crude could see a sharp reversal lower.