Oil prices are still married to European equities -- whether investors like it or not

Oil prices are still 60% lower than they were in June 2014 — and it’s causing havoc with the markets.

Unfortunately, despite a camp of investors and analysts insisting that the correlation between oil prices and stocks are starting to decouple, Tom Pearce and his team at Deutsche Bank said that this is not the case.

In fact, they say that when oil prices fall, European stocks are likely to fall. This isn’t great news considering oil prices are set to stay low and not reach triple digit highs for years.

This is what Pearce and his team at Deutsche Bank said in a note to clients on Tuesday (emphasis ours):

Clients have suggested to us that the reduced stress in the oil market means that the relevance of oil as a driver of the European equity market is diminishing.

We see little sign of this: the 3-month and 6-month correlation between the oil price and European equities are still at a four-year high.

Furthermore, the most important macro driver for the European market remains US high-yield spreads, which continue to move in line with oil prices.

The historical price pattern suggests that the credit market’s sensitivity to oil only diminishes once the oil price rises above $55/bbl — and that the equity market’s strong positive correlation with the oil price only disappears when oil rises above $70/bbl.

We are still concerned about the outlook for oil, given that the rebound in global growth momentum appears to be fading, dollar strength remains a risk and oil net speculative positions are already elevated.

Oil prices are low and volatile at the moment. While they are mildly up on Tuesday around $45 per barrel, oil prices have been obliterated since the summer of 2014:

Any upticks in prices have proven pointless in the short term as oil keeps rebounding between $30 to $50 per barrel.

Forecasts have been pretty bleak too and some analysts are calling for the end of the high oil price era meaning that, if Deutsche Bank is correct, European equities could suffer for longer too.

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