Retail Stocks and Gas Prices: Is the Link Just a Myth?

by Daniel Putnam | June 2, 2014 9:02 am

Retail Stocks and Gas Prices: Is the Link Just a Myth?

The average investor, asked about the correlation between gas prices and retail stocks, would almost always tell you that the two assets move in opposite directions. This seems to make sense, given that a one-cent move in the price of gasoline costs U.S. consumers $1 billion — a big chunk of change that can’t be used for discretionary purchases.

In reality, however, gas prices and retail shares have in fact shown a strong positive correlation in recent years. Generally speaking, rising gas prices have been accompanied by rising prices for retail stocks — the opposite of what the conventional wisdom would predict. This indicates that investors need to consider other factors when assessing the recent performance of the retail sector.

To see how tightly the two assets have matched each other, a quick glance at the charts of United States Gasoline Fund (UGA[1]) and SPDR S&P Retail ETF (XRT[2]) should suffice. Although the magnitude of returns is much different, the direction is almost always the same.

gas Retail Stocks and Gas Prices: Is the Link Just a Myth?[3]

SPDR S&P Retail ETF (XRT) vs. United States Gasoline Fund (UGA)

This is borne out by the correlation numbers. In the past five years, UGA and XRT have a correlation of 0.89. Keep in mind that correlations run on a scale from -1.0 (perfect negative correlation) to 1.0 (perfectly positive). This indicates that retail stocks and gas prices, albeit imperfectly measured by the ETF, are about as perfectly correlated as two different assets can be.

How Is This Possible?

It’s surprising that such a widely-held belief could run so far afield from the actual results, so it pays to think about what’s driving these returns. The most likely answer is that commodities are increasingly acting as a financial asset, with capital flows in the futures markets playing a larger role in performance relative to traditional supply-and-demand factors than in the past.

One important result of this shift is that a commodity such as unleaded gasoline can be influenced by the same risk-on/risk-off type of trading as stocks, bonds, and other financial assets. It’s also worth considering that the period in question incorporates the recovery from the financial crisis, which resulted in a recovery in both stock prices and demand for gasoline.

Weaker Correlation in 2014

Having said all of this, it should be noted that the correlation between XRT and UGA has broken down somewhat in the past few months, during which gas prices have moved gradually higher and retail shares have traded sideways.

This makes it easy to blame the rising price at the pump for the underperformance of the retail sector. In reality, however, the sluggish performance of retail stocks likely has more to do with the fact that the sector had become too richly valued to keep rising in the face of weaker-than-expected economic data. The XRT ETF entered 2014 with a five-year total return of 359%, well above the 127% gain of the SPDR S&P 500 ETF (SPY[4]). With that sort of performance in the rear-view mirror, there was little margin for error.

The Bottom Line

Relationships between asset classes can turn on a dime, so be careful reading too much into retail stocks’ ability to shake off rising gas prices in recent years. If gasoline prices shoot higher this summer, investors’ reflexive reaction will be to sell shares of retailers regardless of the correlation numbers set forth here.

Instead, the lesson runs deeper: Before assuming the conventional wisdom is correct, do some digging. The actual results may just surprise you.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.

Endnotes:
  1. UGA: http://studio-5.financialcontent.com/investplace/quote?Symbol=UGA
  2. XRT: http://studio-5.financialcontent.com/investplace/quote?Symbol=XRT
  3. [Image]: http://investorplace.com/wp-content/uploads/2014/05/gas.gif
  4. SPY: http://studio-5.financialcontent.com/investplace/quote?Symbol=SPY

Source URL: http://investorplace.com/2014/06/retail-stocks-gasoline-gas-prices/
Short URL: http://invstplc.com/1l0qWut