Financial Conditions Drive Stocks, Not Oil Prices
What you missed this week in Navigating The Markets
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There are many things happening at once, which is creating a fair amount of confusion in the market. As I noted around 6 or 7 AM ET, it was clear that even with oil up roughly 6–7%, the credit and FX markets were not overly concerned. This again points back to the framework I laid out a few weeks ago: this is ultimately about financial conditions. If financial conditions are not tightening, then the stock market can rebound. For now, financial conditions are not tightening.
But as I noted in the article over the weekend in 2022, there was a lag. That is why watching credit spreads is likely the most important signal right now. Even in 2023, credit spreads widened after oil prices surged.
Additionally, rates have stalled following a very large move, and as long as Treasury yields are not rising, financial conditions are not tightening. That could change, though. When looking at the 10-year Treasury, it is possible to outline a developing bull flag pattern. If that proves correct, the backdrop for equities would likely shift meaningfully. However, for now, rates remain highly dependent on the path of oil and inflation.
You can see something similar in gold, which appears to be forming a bear flag. The move in gold since late February also seems tied to rising rates — an observation that ultimately links back to oil.
So, if gold is forming a bear flag while rates are forming a bull flag, it suggests that we are currently in a period of consolidation in both rates and financial conditions as the market digests recent developments. If the bear flag in gold plays out, it would likely imply a move back below $4,000.
The same goes for the S&P 500, which is trading in line with rates. This again suggests that stock prices are not responding to the actual swings in oil prices, but rather to the financial conditions created by those moves.
For now, we can wait and see how things play out, but the 1966 analogue suggests this recent rally may end soon.
Mike
Glossary by ChatGPT
Bear Flag: A technical chart pattern indicating a temporary consolidation before a continuation of a downward trend.
Bull Flag: A technical chart pattern signaling a brief consolidation before a continuation of an upward trend.
Credit Spreads: The difference in yield between corporate bonds and comparable government bonds, used as a measure of credit risk and financial stress.
Financial Conditions: A broad measure of market liquidity, interest rates, credit availability, and risk appetite that influences economic and asset price behavior.
Foreign Exchange (FX): The global market for trading currencies, often reflecting macroeconomic sentiment and capital flows.
Treasury Yields: The interest rates paid on U.S. government debt securities, which influence borrowing costs and financial conditions across markets.
Disclosure
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