Why Crude Poses A Risk To Stocks

JC Parets
June 28, 2020

From the desk of Tom Bruni @BruniCharting

We continue to focus on buying the strongest stocks, but we're also always playing devil's advocate by identifying risks to the bull thesis.

Two weeks ago, I outlined the "Island Reversals" and other areas of resistance in many global indices. Today, most of these indices are still stuck below those levels and instead are pushing towards multi-week lows.

Last week we looked at the weakness of US Financials on an absolute and relative basis and the S&P 500 failing to exceed resistance relative to two of its most liquid alternatives, US Treasury Bonds and Gold.

Today, I want to look at Crude Oil and why I'm adding it to our list of risks to the Equity bull case.

First, let's look at Crude Oil on an absolute basis. To adjust for the price action in the May contract where prices went negative, we're using the continuous futures contract that uses the second month rather than the front-month contract.

Prices are currently running into resistance near the top of the price gap from early March and the December 2018 lows, at roughly 42.50, while momentum diverges negatively. In the lower panel, we're looking at its correlation with S&P 500 Futures (which are using the same contract structure for consistency), and we can see a positive relationship between the two that's getting stronger.

Click on the chart to enlarge view.

How prices react to this particular area of resistance will be important, given its correlation with the S&P 500. Do prices work through this overhead supply over time? Or is this the end of the rally, and we're about to collapse?

To help answer that, let's look at US Energy stocks. The major ETFs we track ended last week at 4-to-5-week lows, showing the same weakness we see in the other cyclical sectors like Financials and Industrials.

Just as Energy stocks were a leading indicator at the low, they may now be acting as a leading indicator to the downside and suggesting Crude Oil will correct through price as well.

Correlations are always changing, but for now, the positive correlation is intact, and therefore we need to be paying attention to Crude Oil in the days/weeks ahead.

So what do you think? Is Crude Oil about to collapse? Or is this a quick stop before new highs? Let us know.

- Bruni

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