As the energy complex has emerged from the ashes of the financial meltdown, strange correlations have developed. Stock prices and treasury yields, normally moving in opposite directions, are both moving higher together. Consumer discretionary stocks and energy prices, normally inversely correlated have recently been moving higher together. Will market participants be able to continue keying off these unusual relationships in the months ahead to improve trading profits?
In a normal economic environment, higher energy prices trigger discretionary consumer stocks lower. When consumers have to pay more for gas, they cut back on non-essential goods. However, a very unusual correlation developed since crude prices bottomed out on March 9th of this year. The price of crude and the price of consumer discretionary stocks have risen in tandem. Crude has risen 60% off this year's lows. The S&P consumer discretionary sector has risen 80%.
One of the main reasons we are seeing unusual correlations, such as treasury yields and stock prices both moving higher, is directly due to the Federal Reserve's flood of liquidity. When the economic recovery begins gaining traction and the Fed pulls back on liquidity, correlations will begin to return to normalcy. Until that happens, these strange correlations will continue and astute traders will be able to squeeze a little more juice out of their trades.
One major caveat for energy traders to heed. Commodities always eventually price back to supply and demand. Always have a hedging strategy in place or ready to implement when these fundamental forces return.
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