Oil Spikes Have Always Led to Stock, Commodity Bear Markets

By James Debevec  MAR 07, 2011 1:15 PM

Detailed analysis to help investors better understand what the recent spike in oil prices means going forward.


There have been quite a few good charts making the rounds over the past couple of weeks with respect to oil spikes. They all seem to have a pretty common theme. When oil spikes, like it recently has, a recession almost invariably follows. While this is interesting from an economical perspective, what does an oil spike mean for stocks and commodities? Let’s take a look.

From 1920 to 1970 oil did not really have any rallies that were too epic.

From July 1973 to November 1975, oil prices skyrocketed 322%. It was both the longest spike time-wise and had the highest percentage gain. Stocks experienced a 48% bear market from January 1973 to October 1974. Commodities peaked in July 1974 and then went into a 23% bear market that bottomed in February 1975. Commodities would not go above their August 1974 high until late 1978.

Oil spent 1976 to 1978 in a consolidation pattern (up less than 1% cumulatively in those three years) before embarking into a final blow-off top phase. From December 1978 to February 1981, oil went up 161%. Stocks peaked on November 1980 and had a 28% bear market that bottomed on August 1982. While commodities peaked in the same month, they fared much worse. Commodities went down 45% in a 21-year bear market that finally ended in November 2001.

Next up is the famed Gulf War spike. Oil went up 235% in two years and five days and peaked October 10, 1990. This is similar to our current spike. Stocks went down 20.3% from July 16, 1990, to October 11, 1990. What about commodities? They peaked on May 1, 1990, and experienced a 2.4-year 19.3% leg down in their two-decade bear market to a temporary October 1992 bottom. Overall commodities would fall 26% to their bear market bottom.

The next oil spike was a 265% move from December 21, 1998, to September 20, 2000. You guessed it. Stocks didn’t care much for this oil spike either. The S&P went down 50% from March 24, 2000, to its October 10, 2000 low. Commodities went down 22% from October 12, 2000, to put in their final bear market intraday low on November 7, 2001.

Thus far this is a nice, clean article. But now things get messy. What exactly is a spike? Oil had strong and steady bull market action from the post 9/11 bottom to the middle of 2006. Whenever oil would start to get too spiky it quickly pulled back. The first time oil had a decent-size pullback for any real length of time was from July 14, 2006, to January 18, 2007, when it went down 35%. Overall from November 2001 to July 2006, oil went up 355% in 4.65 years. Very nice indeed. Is this a spike? Hmm. We will put this one on ice for a bit and come back to it in a minute.

From January 18, 2007, to July 11, 2008, oil went up 195%. Stocks went down 57% from October 11, 2007, to the March 6, 2009 low. Commodities went down 47% from July 2, 2008, to December 5, 2008.

From December 19, 2008, to March 7, 2011, oil has gone up 230% in about 2.21 years. We don’t know how this one is going to end.
Now let’s go back to that pesky 2001-2006 oil rally that was mentioned before.

Oil went up 355% in 4.65 years. But was it a spike? What we are going to do here is take a look once again at the very same six spikes listed above. The first percentage number is how much that oil spike went up in the amount of years listed at the end of the line. The number in parentheses is the maximum the November 2001 to July 2006 oil rally went up in the same number of years.

July 1973 to November 1975: 322% (+160%) return in 2.33 years

December 1978 to February 1981: 161% (+142%) return in 2.17 years

October 1988 to October 1990: 235% (+152%) return in 2.01 years

December 1998 to September 2000: 265% (+138%) return in 1.72 years

January 2007 to July 2008: 195% (+121%) return in 1.48 years

December 2008 to March 2011: 223% (+141%) return in 2.2 years

Just to make this clear, let’s do the first one slowly. Oil went up 322% from July 1973 to November 1975. This was a time period of 2.33 years. The most that oil went up in any rolling 2.33-year period from November 2001 to July 2006 was 160%.

If you look, there was only one time out of the six oil spikes where the 2001-2006 oil bull market got anywhere near being classified as a spike. That was when oil went up 142% in 2.17 years. However, this did not reach the 161% rally leading up to the 1981 top. Therefore, according to this analysis, oil did not have a true spike in 2001-2006. The annualized return for the 2001-2006 oil rally was 38%. For the true oil spikes the annualized returns were 85%, 55%, 82%, 109%, 107%, and at least 71% for the present spike.

So what's the bottom line? In the five prior oil spikes, stocks started a bear market at least three months before the spike hit its peak. If the current oil spike reaches into early May it would be the longest oil spike.

In all five prior oil spikes commodities experienced a bear market. All prior commodity bears started within 22 calendar days of the end of the oil spike at the latest. This corresponds with my previous article, which suggested we should see at least a 36% commodity bear market commence sometime in 2011.

On a final note, some people are saying they will start to worry when oil hits $147. However, when the stock market hit its all-time high on Oct 11, 2007, oil closed at $83.08. If you adjust that for inflation it comes out to $87.56. The stock market hit its recent multi-year high on Feb 18, 2011. On that day, oil closed at $86.20.
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