- Oil is officially in a bear market and one hedge fund manager believes that the stock market will follow suit.
- Overbought equities support the idea that equities are bound for a deep correction.
- Other traders welcome the correction to buy on dips.
Oil just stepped into bear territory. Investors continue to dump the commodity as widespread fears of the rampaging coronavirus will keep people from travelling and dampen demand.
Brent dropped over 20% from its April 2019 high of $74.57 after closing at $58.26 per barrel on Monday. In investing terms, a 20% decline marks the start of an asset’s bear market. Former Goldman Sachs employee Will Meade believes that the stock market will follow suit.
Stocks Have Historically Followed Oil Into Bear Country
The billion-dollar hedge fund manager appears to have a knack for calling market tops and bottoms. Earlier this month, Meade predicted that the marijuana industry will likely bottom out. So far, cannabis stocks are starting to show signs of life.
Just a week ago, he said the coronavirus will ignite a deep stock market plunge. On Monday, the Dow Jones Industrial Average lost over 400 points while the S&P 500 shed over 50 points.
On Monday, Meade took to Twitter to warn that stocks may follow oil’s lead and dump 20% from the top.
I did my due diligence and discovered that the hedge fund manager has a point. Since 1986, oil and stocks have both become bearish in four out of seven occasions.
While the correlation doesn’t necessarily indicate that the stock market will follow oil’s plunge, there are signs that equities are due for a correction.
The Stock Market Is Itching for a Correction
It’s no secret that the stock market is extremely overvalued. At this point, many analysts are saying that the markets are looking for an excuse to correct. Otavio Costa, Crescat Capital portfolio manager, echoes this sentiment. He told CCN.com,
From a technical perspective, stocks and corporate bonds look overbought across several indicators. We believe these last days of rising volatility are just the beginning for a long overdue selloff.
The portfolio manager also says that if oil continues to dump, it could spillover to the stock market. Costa added,
There is a high probability that the selloff in oil prices could trigger a correction in overall stocks. The spread between S&P 500 and oil prices is now at its highest level since the late-2015 and early-2016. During that time, a disorderly downward move in oil prices preceded a correction of close to 15% in stocks. This time, however, equity markets have truly reached historic valuations.
Some Analysts Would Welcome the Plunge
Even though a significant correction may be on the horizon, many traders would take the opportunity to buy the dip. JM Vala, co-founder of Layup Trades, says equity markets may easily shed another 5%. The trader told CCN.com,
Top holdings got stretched way past safety. Most stocks were trading 15-25% above their yearly points of control. Honestly, this market could pull down 10% off today’s close, and I would welcome it for an opportunity to start putting cash to work again.
On the other hand, Alex Kruger does not buy the view that stocks would follow oil into bear county. The economist said,
Stock indices, excluding small caps, are not impacted by oil aside from extreme circumstances.
Kruger added that the selloff was triggered by coronavirus and that its impact will start to fade soon.
Disclaimer: The above should not be considered trading advice from CCN.com. The writer does not have exposure to oil or U.S. stocks.