Could Commodity Weakness Signal a Pullback for the S&P 500?
Real Money's Carley Garner explains how the strong correlation between stocks and commodities could indicate a market correction. Real Money columnist Carley Garner takes a deep dive into the statistics that show how and when stocks and commodities dance in tandem. Read her column to see the charts and get the full story. Garner explains that stocks and commodities tend to trade as one when a massive government stimulus program is in full force. The correlation between the two asset classes becomes highly positive. As goes commodities, so goes stocks, and vice-versa.  Looking at the bigger picture (180 trading days), stats point toward correlation coefficients in the 90s for most major commodity markets vs. the S&P 500, Garner explains. "For example, in this time frame, the S&P 500 futures contract and soybean futures closed in the same direction about 95% of the time. Crude oil, copper, corn, and even hogs shared similar stats. Lumber closed in the same direction about 90% of the time." Taking the long view may reveal that that correlation may foretell matching corrections. Now that we are starting to see signs of weakness in some of these commodities, it is worth considering the possibility of the stock market following suit," Garner writes. "Lumber and copper topped on the same day, May 10, and have mostly been working lower since. While we could certainly get a bounce from what are currently oversold levels, it feels like the runaway commodity bull is getting tired," Garner says. "Since the May 10 reversal in these headline-grabbing commodities, we have seen the grain markets (corn, soybeans, and wheat) struggle to hold gains. The latest gravity-defying commodity to roll over is lean hog futures. If the ongoing positive correlation between these commodity markets and the broad equity market continues, we could see some back and filling in the S&P.  She writes that crude oil is the most important commodity to keep an eye on right now. Perhaps the most important intermarket relationship is the correlation between crude oil and the S&P. I have witnessed this relationship morph over time and even completely flip." "So far in 2021, both crude and the S&P are bullish. West Texas Intermediate Crude futures are up 51% year-to-date. The S&P 500 is up 13.5%, year-to-date," Garner says. The current correlation between oil and the S&P 500 sits at 95%. This means these two assets have been habitually moving in tandem. It also means, if the oil market succumbs to profit-taking as the other commodity markets have, we could see the stock market undergo a healthy correction. This is not to say we are on the verge of a crash, but we are overdue for a digestive move into the high 3,000s in the S&P; last week's dip felt insufficient." Garner says the trend is obviously in favor of the bulls in both the stock market and WTI crude oil. "However, trends are capable of reversing themselves without warning. Tab the boards for clues of a reversal in the energy space... that could lead to something bigger on Wall Street," she writes. "Thus far in 2021, each commodity has undergone the same process of a nearly parabolic rally followed by catastrophic losses. It is nave to believe crude oil will be the exception. It wasn't that long ago that the masses were convinced lumber, hogs, and the grains could only go higher. Now we are wondering how low is too low. Garner writes.