Here's why stock market bulls should cheer the drop in oil
Oil prices staged a reversal on Tuesday, rising out of negative territory as traders reacted to a government report that forecasts a cut in U.S. production next year.
Now, options-focused fund manager Dennis Davitt of Harvest Volatility Management is watching crude closely, as he believes these historically low oil prices may spur economic growth. Despite Tuesday's small bounce, oil futures (New York Mercantile Exchange: @CL.1) are still down nearly 15 percent year to date.
Lower crude prices have traditionally been associated with slowing economic activity, Davitt said, though now falling prices may be a positive factor for the broader economy and the consumer.
"The positive knock-on effects of lower energy prices can be seen at the pump. When people are spending under $2 per gallon for gasoline, it gives them considerably more discretionary income that they can spend on other things ... that in the past went right into their fuel tanks," Davitt said.
Beyond the consumer impact, oil prices are one of the primary inputs in the cost of manufacturing, Davitt said Tuesday on CNBC's "Trading Nation," whether that means the cost of plastic materials or the overall cost of electricity and energy.
"Lower crude oil prices in the United States will certainly provide a tail wind for manufacturing and overall economic activity in the United States versus the rest of the world," he said.
Meanwhile, stocks have managed to hold up rather well even as oil has tumbled, Davitt points out.
Indeed, the energy sector has shrunk as a percentage of the S&P 500 (INDEX: .SPX). The sector comprised about 12 percent of the index in 2011; now the energy stocks, closely tied to oil prices, make up less than 6 percent of the overall market. As a result, the correlation between the broader market and energy stocks has fallen — along with the correlation between the S&P 500 and oil itself.
Still, for those looking to play for an oil reversal, Davitt recommends looking to the VanEck Vectors Oil Services exchange-traded fund (OIH (NYSE Arca: OIH)), which has fallen 26 percent year to date while crude has dropped nearly 15 percent in the same time as oversupply remains a concern for the market.
"If you need to pick a bottom in the energy sector, that would be a good one to own," he said of the OIH.
Oil settled more than 1 percent higher on Tuesday at $45.04 per barrel, well off session lows.
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