Recalculating the Oil Tax

Will Alan Greenspan drop his belief that rising oil is a 'transitory' trend?
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Oil's flirtation with $61 a barrel and a drumbeat of queasy earnings news had investors fretting about the economy's future Monday.

Crude for August delivery gained 70 cents on the day to $60.54 a barrel, after briefly trading above $61 on Nymex.

International Paper

(IP) - Get Report

issued an ugly profit warning, while

Cardinal Health

(CAH) - Get Report

also signaled pain.

Traders also eyed this week's meeting of the

Federal Reserve Open Market Committee

. Policymakers are expected to deliver their ninth straight quarter-point rate hike in a year on Thursday. As usual, what they say will be more important than what they do.

The last time Fed Chairman Alan Greenspan discussed how rising energy prices might affect the economy, he dismissed the trend as "transitory." But with oil over $60 now, some market players are now hoping that the Fed will reappraise the risk to growth.

Traders in bond pits certainly seemed to fall into that camp Monday. The benchmark 10-year Treasury bond rose another 3/32 while its yield fell to 3.91%.

And the major stock proxies, which went into a tailspin last week as oil flirted with $60, may have also seen their losses cushioned Monday by hopes that the Fed would soften its policy. The

Dow Jones Industrial Average

fell 7.06 points, or 0.07%, to 10,290.78; the

S&P 500 index

dropped 0.88 points, or 0.07%, to 1190.69; the

Nasdaq Composite

fell 8.07 points, or 0.39%, to 2045.20.

Trading volume was very light, with only 976 million shares changing hands on the

New York Stock Exchange

and 1.2 billion trading on the Nasdaq.

Besides IP, which lost 3%,

Nike

(NKE) - Get Report

fell 4% after saying sales growth in the current quarter will be at the low end of its previous 7%-9% guidance. While the company didn't mention a currency impact, its sales growth of 6.7% in the previous quarter was partly credited to a lower dollar.

In the desperate search to give more fodder to the Fed's end-of-rake-hikes scenario, Wall Street may also start considering the impact of the strong dollar on earnings going forward. More than 30% of S&P 500 companies' revenue come from overseas operations, according to Merrill Lynch.

As mentioned here two weeks ago, Merrill economist David Rosenberg believes that the dollar's surprising upside against major currencies this year hasn't been taken into account into most analysts earnings forecasts.

On Monday, the dollar actually fell against the euro as several European central bank officials rejected the idea that eurozone rates may come down this year. But the dollar has still gained about 3% against major currencies so far this year, against expectations it would decline 10% in 2005.

If the dollar merely maintains its year-to-date gains, Rosenberg said, the consensus operating EPS for 2005 for the S&P 500 would fall to $72.80 from $74.50, according to Rosenberg. In terms of comparisons, year-on-year growth would fall to 7.6% from 10%.

Elsewhere, Merrill U.S. strategist Richard Bernstein expanded on his argument that Wall Street is ignoring the possibility profit growth will slow in a period during of Fed tightening.

In every slowing profit growth cycle of the past 20 years, he says, analysts have typically been cutting their estimates at this stage of the game. This time around, "they have been raising estimates at a near record pace."

Perhaps as a sign of this trend, Thomson Financial research shows that earnings growth estimates for the second quarter have moved up to 6.9% this week from 6.8% last week.

"In our view, perhaps the main reason for this break from history is the consensus view that cyclical companies are no longer cyclical," Bernstein wrote to clients. Investors remain under the misguided belief that energy, materials and technology, in particular, are now immune to slowing profits and the Fed's tightening.

Part of the problem, says Bernstein, is that Regulation FD is limiting the ability of analysts to conduct proprietary research and has forced them to rely increasingly on company guidance. And cyclical companies "rarely admit to their inherent cyclicality until it is obvious and often too late."

The impact of the rising dollar, which should have brought revisions to earnings forecasts, is only exacerbating those discrepancies. But it's also creating a trading opportunity, according to Bernstein.

On the one hand, industries and stocks with strong earnings momentum -- such as chemicals, commercial services, communications equipment, machinery, semiconductors and road and rail -- are at most risk of negative surprises due to the strong dollar.

Food products and healthcare providers were singled out by Bernstein as industries whose earnings prospects could, perhaps counter-intuitively, benefit from an appreciating dollar.

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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