Oil’s big assault on stocks will end in time when consumers start spending

Among other things, the 66% plunge in oil since June 2014 has been a disaster for Standard & Poor’s 500 Index earnings, sucking the life out of energy companies while failing to ignite consumer spending.
Oil’s big assault on stocks will end in time when consumers start spending

One analyst says that cycle has run its course.

Even a plunge in crude to Wall Street’s worst-case level of $20 a barrel is unlikely to do additional harm to S&P 500 profits, according to Gina Martin-Adams of Wells Fargo Securities, who says a stabilisation at that price would probably unleash a windfall of consumer spending that has so far proven elusive.

Unthinkable two years ago, oil at $20 has become a possibility to Citigroup and Goldman Sachs Group, while options traders have started buying contracts that pay out at that price.

“Our assumption is that if oil falls to $20, it will result in profits during the first half of the year being weaker than expected but in the second half of the year being stronger than expected,” Ms Martin-Adams, equity strategist at Wells Fargo, said.

Tumbling oil affects S&P 500 earnings in three ways, two of them bad.

It lowers earnings in the energy industry, which makes up 6.4% of the full index, and puts a chill on capital spending.

At some point, cheaper oil is supposed to lead consumers to open their wallets.

The failure of that to happen has made crude’s retreat almost unilaterally negative for corporate profits, which are poised to slide for a third consecutive quarter in the three months through December.

Higher spending by consumers has historically lagged behind big shocks in crude prices by about 19 months, said Ms Martin-Adams.

Americans delayed using any extra cash when oil prices plunged almost 70% over five months starting in 1985, and again in 1991, when crude tumbled more than 56%, the analyst said.

Crude has dropped more than 30% this year and is down by two-thirds since June 2014.

Heading into 2015, some stocks seers expected consumers to start spending their windfall from the pumps and overestimated the benefits from lower oil prices.

One reason their optimism wasn’t rewarded is that equities take a bigger cue from business spending, and so much of that is tied to commodities prices, a point Bank of America made at the start of the year.

As oil continued its slide this year, S&P 500 companies saw the smallest increase in capital expenditures since 2009.

At the same time, earning for S&P 500 companies are on pace to contract by 0.6% this year. While profits in the consumer discretionary sector are forecast to rise 10%, energy sector income will contract by 59%.

Analysts see further declines for energy next year, with profits slated to slump 7%. The S&P 500 as a whole will see profit growth of 7.1%.

Citigroup’s Tobias Levkovich said should oil tumble to $20, earnings gains in the index may evaporate, as potential unexpected consequences include further disruption in gas and oil production and company bankruptcies.

“S&P 500 profit growth was flat this year, as other parts of the economy filled the gap in growth,” created by energy companies, Levkovich, Citigroup’s chief US equity strategist, said.

“But if you get to $20 a barrel, you’re probably going to see greater economic difficulties, and therefore it wouldn’t fill the gap.”

While the another 50% drop in oil would weigh on stocks and profits during the first half of 2016, consumer spending in the second half would fuel growth in industrial production and in the auto and technology industries, according to Ms Martin-Adams.

Materials companies would also benefit from lower input costs, she said.

Costs at the US gas pump are already the cheapest since 2009.

That helped lift gross domestic product in the third quarter, with household purchases propelling demand.

Wal-Mart stores, whose shares have tumbled 30% in 2015, is positioned to outperform next year because its core customers — who earn about $35,000 a year — spend a bigger share of their income on fuel, according to Nomura Securities.

“What happens when oil prices move as rapidly as they have is you get a transition period,” Ms Martin-Adams said.

Consumers “need to plan and react to the new price deck,” she said.

“You get to that point of stability, and then the economy moves forward.”

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