Little Love for Lower Oil

A nearly $3 plunge in September crude does little for stocks.
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With oil plunging, stocks should have bounced Wednesday, right? Especially after a selloff that lopped 120 points off the

Dow

a session earlier. But lower oil and better-than-expected earnings from

Hewlett-Packard

(HPQ) - Get Report

equaled small gains for the major averages, evidence of a lack of buying spirit in this mid-August market.

Still, as crude oil tumbled $2.83, or 4.3%, to close at $63.25 in Nymex trading, it was a little easier for investors to ignore more evidence Wednesday that energy inflation is already hurting businesses.

After

Wal-Mart

(WMT) - Get Report

warned Tuesday that gasoline prices were pressuring its customers and would hit sales -- leading to the Dow's woes -- a much stronger-than-expected July producer price index Wednesday suggested profit-margins are getting squeezed.

This, however, didn't stand in the way of what was mostly a technical bounce. Traders said Tuesday's more-than-1% plunge in the major averages triggered buying interest, with many trades being placed at the

S&P 500's

50-day moving average at 1218. The broad average didn't really move much above that level, rising 0.90 point, or 0.07%, to 1220.24.

The Dow Jones Industrial Average finished with a gain of 37.26 points, or 0.35%, at 10,550.71. H-P, which soared more than 13% after issuing an upbeat earnings outlook, was largely responsible for the rise in the blue-chip average.

The

Nasdaq Composite

gained 8.09 points, or 0.38%, to 2145.15. Gains in the tech-heavy index also were fueled by

Applied Materials

(AMAT) - Get Report

, which reported better-than-expected earnings.

Volume remained light, with only 1.4 billion shares trading on the

NYSE

and 1.6 billion on the Nasdaq. Another sign that the bounce lacked conviction was negative breadth on the NYSE, where decliners outpaced gaining issues 17 to 14. On the Nasdaq, breadth was barely positive with advancing issues outpacing declining ones 15 to 14.

"The S&P held its ground

at 1218 but given the lack of conviction in this bounce, if we get another day like this, then this market is a sale," says Eliot Spar, market strategist at Ryan, Beck & Co.

Particularly disappointing, he says, was that this modest uptrend in stocks took place as crude oil prices fell nearly $3, which should have provided much more relief as "people were talking about crude at $70 wrecking the economy."

But in this market, which remains driven by its own momentum, fundamentals are still taking a back seat, and will remain there until the market seeks catalysts to head lower. When it does, investors may wake up to an environment that's turned quite unfriendly for profit margins.

Soaring oil and gasoline prices are likely to further pressure consumers, as Wal-Mart's profit warning suggested. On Tuesday, the government said that the consumer price index rose a larger-than-expected 0.5% in July due to higher energy prices.

But the consumer is only one side of the equation. When juxtaposing the July CPI with Wednesday's much-larger-than-expected July producer price index, the result shows that firms are seeing their costs soar but are not passing them on to consumers.

The PPI rose 1.0% in July, double what Wall Street economists were expecting on average. The rise was mostly due a 10.9% gain in gasoline prices. Excluding food and energy prices, the core PPI rose 0.4%, four times as much as economists expected.

The report fueled losses in inflation-weary bond pits, where the benchmark 10-year Treasury bond fell 16/32 and its yield rose to 4.27%.

Yet, unusual gains in the core PPI came from rising light-truck and car prices as automakers offered discount prices in June, instead of July, as is customary. Over the two months, vehicle prices fell slightly on average.

But for businesses, which can't dismiss energy prices, the bottom line is that input costs are rising. And to make matters worse, with consumers also getting squeezed with the prices of gasoline rising, "many companies would like to pass higher costs along, but in most cases they just can't," says Mark Vitner, senior economist with Wachovia.

The troubles won't stop there for profits and for stock valuations, according to J.P. Morgan equity strategist Abhijit Chakrabortti. Profit margins are at 40-year highs, he says, and in the wake of strong economic data -- and better-than-expected second-quarter earnings -- investors are now expecting more of the same.

"Right now, the equity market appears to believe in the best of both of all worlds -- further margin improvement despite strong growth in input prices, and strong final demand despite high energy prices, rising interest rates and muted wage growth," Chakrabortti wrote in a note Tuesday.

Throw in a stronger-than-expected dollar so far in 2005, and all the factors are there for profit margins to be shrinking. Stock prices may only start reflecting this trend when other companies beside Wal-Mart start issuing profit-warnings.

To view Aaron Task's video take on today's market, click here

.

In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;

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