Historic Dance: WTI and the DJIA

You probably noticed the unusually strong correlation between the changes in the WTI price and the DJIA average that has been occurring lately. The stat people can put a number on this, it's the correlation coefficient R-squared. A value of 1 is perfect, a value of 0 is no correlation. You can pretty easily get the number for any 10-day period as far back as you want to go. "Perfect" may be either in lock step, where one goes up followed by the other, or "perfectly divergent" in which an increase in one occurs with a decrease in the other.

Between 2000 and now, the correlation between the daily price change in WTI and the Dow has averaged 0.14, pretty weak. The prices of one typically do not move in conjunction with the prices of the other very much. The R-squared value for the above 10-day period was .82, quite strong, as we have noticed.

If you go back over the last couple of years, back to early 2008, there were seven time periods during which there was a strong correlation between the WTI price change and the Dow price change, and the baseline value is much higher than the historical average.





Of these "major instances", 6 of the 7 were similar to the case above, The lone exception was the period in May of 2008 during which the WTI price and the DJIA price were strongly divergent;


In fact, historically, this was the more common occurrence. Take this example, which occurred during the Iraq invasion of Kuwait and run up to Operation Desert Storm:






There were four instances between August of 1990 and September of 91 during which the two markets danced either together, or divergently.

But, the point is this: As far back as the WTI records go, to 1983, the incidences of the WTI and Dow being closely correlated (defined by an R-squared of greater than .7) are exceptionally rare. Even during the DJIA meltdown in 1987, WTI scarcely moved. Since 1983 there have only been 16 events of this nature, and 7 of them have occurred in the last 2 years, since the financial problems started to show up in the global economy.

So for the time being, the caution for parties interested in either index is: we are witnessing an unprecedented dance between the WTI price and other measurements of market value. No doubt both are being influenced by the same market emotion or other underlying factor, i.e. the strength of the dollar and general stability in the financial system. The strong correlation is undoubtedly a sign of continued stress in the financial system and other markets.