The surge in oil prices seen early this week after the attack at the heart of Saudi Arabia’s oil industry will have to go a lot further to cause serious trouble for the stock market.
That’s according to JPMorgan’s (NYSE: JPM) Marko Kolanovic, the firm’s global head of macro quantitative and derivatives strategy.
Kolanovic says that the S&P 500 may start experiencing a “negative impact” only when oil prices surge to $80 to $85 per barrel, which is roughly 36% above the current price of crude.
According to the quant strategist, when oil prices are stable, oil correlates positively with the S&P 500, but when there are large price increases, that correlation weakens and turns negative.
Higher oil prices can boost energy sector profits and employment in the industry, but Kolanovic said in the note that a rapid surge in energy prices could hurt consumer spending, which is a key support for the U.S. economy.
Monday’s 15% price surge was one of the fastest on record, though crude still trades at less than half the peak level seen in 2008.
“Where is the break-even point when oil starts hurting the S&P 500?” Kolanovic wrote. “This is still far away.”
That’s not to say that oil has no impact on stocks at current levels. The energy sector jumped 3.3% on Monday as crude prices surged higher, offsetting losses in consumer stocks.
According to Kolanovic, that outperformance will accelerate the rotation from momentum and low-volatility stocks and into value that the market has been experiencing in the last few weeks, which has lifted previously unloved sectors like energy while also inflicting pain for many traders over the last month.
This rotation stemmed from when valuations in low-volatility and momentum stocks increased to unprecedented levels relative to value. To Kolanovic, so much money has flowed into the long low-vol, short value trade that it’s reminiscent of the volpocalypse of 2018.
In late 2017, the market calm lured investors into a sense of complacency and bets on a fall in volatility reached a record. That trade went bust in February 2018 and led to the closure of VelocityShares Daily Inverse VIX Short-Term ETN, known by its XIV ticker.
Ever since, investors have been seeking safety in low-vol and have shunned riskier assets such as energy, which has pushed the risk-off trade to extremes that Kolanovic says are at the cusp of collapsing just like the XIV.
“These trades worked well until the rotation started, and now are in the early stages of collapse,” Kolanovic wrote. “The recent spike in oil will just accelerate this unwind and eventually lead to a capitulation of the short value/beta trade.”
Kolanovic is positive on the stock market through this year and sees both oil and natural gas prices moving higher, which should drive energy stocks higher.
“Oil futures have been trading in a tight range below 50 100 and 200d moving average, and below 12 month momentum term and hence shorted by trend followers,” Kolanovic wrote. “With [Monday’s] move, spot has broken through all the averages and there should be significant short covering ahead.”