Why Stocks Aren't Fretting Over Rising Oil
Aaron Task
07/16/07 - 04:51 PM EDT
The
Dow Jones Industrial Average and
S&P 500 pushed deeper into record territory early Monday as crude prices lifted above $74.30 per barrel. The stock market gains then faded in the afternoon as crude retreated, before finally settling 22 cents higher at $74.15.
Judging by what you read and hear in the financial press, this kind of symbiotic action is either impossible or inexplicable and certainly unusual. But the facts say otherwise, and recent history suggests the conventional wisdom is dead wrong regarding energy's effect, or lack thereof, on the stock market.
For months on
The Real Story podcast and the past two weeks in the
TheStreet.com's "What a Week" column, I have discussed how higher energy prices are not necessarily a negative for the stock market and even have some positive implications. The short answer is that energy stocks are having a bigger influence on the major averages while strength in the underlying commodity reflects a robust global economy -- facts seemingly lost on most reporters.
"Even though it's been negative for consumer spending, higher oil prices have clearly not derailed the stock market," says Howard Simons, strategist at Bianco Research in Chicago and
RealMoney.com contributor. "Crude is being pulled higher by strong economic growth -- if corporations can buy crude for $1 and can produce $1.10 in economic value, it's not a negative."
Simons also notes something seemingly lost in a lot of the coverage -- including Saturday's
Wall Street Journal story in which he was quoted essentially refuting the thesis of a piece entitled "In a Rare Pairing, Blue Chips and Oil Climb Together." Crude prices have been in a bull market since 1999 -- save for immediately after the Sept. 11 terror attacks -- but have not slowed the stock market's robust advance since its bottom in late 2002/early 2003.
"There's a powerful statistical correlation that the sectors that get helped by higher energy prices have greatly outweighed the negative impact spread over a much larger group of stocks, chiefly in consumer discretionary," says Simons, who detailed these relationships in a
RealMoney.com column back in May. (
RealMoney.com subscription required.)
In other words, for every struggling retailer like
Sears Holdings (SHLD Quote),
Home Depot (HD Quote) and
Circuit City(CC Quote) there are energy stocks like
Exxon Mobil (XOM Quote),
Chevron (CVX Quote) and
ConocoPhillips (COP Quote), which are having a greater, positive influence on blue-chip averages.
The rising long-term significance of energy stocks such as within the S&P 500 can be seen in the chart below. In the short term, Monday's session saw energy stocks as the biggest drags on the index, which closed down 0.2% at 1,549.52 after trading as high as 1555.90 intraday.
 |
| Source: Natexis Blechroeder |
The less obvious answer as to why rising crude hasn't scuttled the bull market is that energy is a far less important factor in inflation and corporate profits as it was during the 1970s.
Amid the energy price shocks of the '70s, 35% of American workers were unionized and organized labor was able to demand and receive "cost of living adjustments" for workers, says Tobias Levkovich, chief U.S. market strategist at Citigroup. Today, only about 6% of U.S. workers are unionized and unions are giving concessions. "Oil has risen more than seven-fold from $9 in 1998 and there hasn't been a [corresponding] uptick in wage inflation," he says, explaining why energy prices haven't driven inflation higher and forced the
Federal Reserve to tighten, as many bears forecast.
This is significant because energy costs represent about 7% of S&P 500 companies' costs vs. 70% for labor, Levkovich says. Nevertheless, the financial press continues to refer to the 1970s-era playbook and fret about the "threat" rising crude prices presents to the bull case.
But while wages haven't risen at nearly the same pace as energy prices, it hasn't "destroyed consumption," says Levkovich, who cites two main reasons.
First, the average worker earns a median income of $45,000 per year, the strategist says. At that level, a standard 3% to 4% wage increase offsets rising energy prices, even if the person "doesn't have much left over" for discretionary spending.
Second, "the 20% of American income-earners account for 40% of consumer spending, or more than five times the bottom quintile," Levkovich says. "The upper-end consumer owns stock [in greater proportion than the average American] and the 'wealth effect' is more-than offsetting the bite of energy."
This in turn helps explain why high-end retailers like
Saks (SKS Quote) and
Nordstrom (JWN Quote) continue to outperform.
Investing Implications
Having said all that, I will reiterate caution about the short-term outlook for energy stocks. Anecdotally, the papers are full of reports about possible energy supply glitches, from the IEA last week and the National Resource Council today. At the same time, Wall Street firms are ratcheting up their oil-price forecasts, including Goldman Sachs and Deutsche Bank on Monday.
Furthermore, energy stocks have begun to lag behind the performance of the underlying commodity, as Helene Meisler and I discussed in a
video last week and a scenario that played out again Monday.
Furthermore, there's been a smattering of bad news from companies like
Baker Hughes (BHI Quote) and
Marathon Oil (MRO Quote) in the past week as well as second-tier outfits like
Rosetta Resources (ROSE Quote) and
Lufkin Industries (LUFK Quote).
Citigroup's Levkovich, who remains "steadfastly bullish" overall and positively disposed on major integrated oil companies is "less excited" about oil services firms, citing less compelling valuations.
Finally, as we head into the heart of earnings season, it's worth
repeating that sell-side analysts expect just 2% year-over-year earnings growth for the energy sector, according to Thomson Financial vs. 4.4% for the S&P 500 overall.
This combination of factors, along with the prevailing positive sentiment for all things energy, suggest near-term weakness ahead for the sector, even if the long-term outlook remains upbeat. Not coincidentally, the same view applies to the broader market.
