What cheaper oil means for investors, consumers and the economy
John Authers
Impact on markets is hard to gauge, but the average American will benefit
Oil is growing cheaper. This we know. Now for the hard question: who will profit from this?
Some answers are straightforward. Large oil-exporting countries that are particularly dependent on oil revenues, such as Russia or Venezuela, stand to lose grievously. Motorists in countries where the car is dominant and petrol is lightly taxed, such as the US, stand to benefit.
But the array of possibilities for investors is more complicated. Oil prices feed directly into inflation and hence affect the actions of central banks, who are as important as ever. The oil price spike of 2008 prompted the European Central Bank to make one of the most egregious monetary policy errors of recent years, raising rates on the eve of a credit crisis – so shifts in oil bring risks, and can require big shifts in asset allocation.
Further, the effect on the overall stock market is muffled as oil is an expense for many – but revenue for some. It is large oil companies who feel the pain of sharply falling oil prices first. They can be expected to adjust their behaviour, in ways that have knock-on effects for investors and consumers.
Finally, while a sharp reduction in the price of an important commodity is always meaningful, and crude oil has dropped by a quarter since June, much depends on where the price moves from here. If it resets at about its current level, or drops further and stays there for a matter of years, the effects would amplify as time goes on.
All of this makes the impact of cheaper oil on markets hard to gauge. However, David Kostin, US equity strategist at Goldman Sachs, produces a sensitivity analysis that suggests that Brent oil of $84 per barrel, roughly where it is now, is consistent with 5 per cent earnings growth for S&P 500 stocks this year, and 8 per cent next. A drop to $74 would move numbers up by a percentage point. Meanwhile Brent oil at $114 – roughly where it traded for the first half of this year, would be consistent with earnings growth of only 1 per cent for this year – so the oil market has definitely been a net boon to developed world stock markets.
But does the flow of oil leave bargains in its wake? Oddly, the greatest beneficiaries may be oil companies themselves. According to MSCI indices, the world energy sector is down 5.5 per cent for the year, while equities as a whole are up almost 3 per cent – and sectors such as information technology and healthcare have logged double-digit gains.
How will oil companies respond? First, they will cut costs, which is tough for the economy. In the US, capital expenditure is dominated by energy companies, so cutbacks will trickle down to hurt others. Eventually, as they cut capacity and supply, prices will rise – that is how commodities markets work.
But if they are not spending money on capex, there is a chance they will pay it to shareholders, through dividends or buybacks of stock. This is a well-tested way for companies that have ceased growing to keep their share prices high. If rates on bonds stay low for longer (and the cheap oil price adds to the weight of factors keeping rates low), then income from stocks, in the form of dividend yield, grows more appealing.
As the chart shows, this is already happening. If oil companies do start managing themselves for cash, and the hunt for yield stays intense, they could be surprisingly strong performers.
Who else benefits? Transportation stocks (up almost 11 per cent for the year according to MSCI) are the clearest beneficiaries. Others are less obvious, but centred in consumer discretionary stocks – which have disappointed investors with their earnings for the third quarter. Gambling groups, soda manufacturers or large retailers, stand to receive some of the $70bn per year that US consumers could save on petrol if crude prices stay low. According to Jonathan Glionna, US equity strategist at Barclays, an index of 20 US beneficiaries from cheaper oil has outperformed the S&P 500 by 6 per cent since crude started falling in midsummer.
For broader market dynamics, cheaper oil feeds into the almost perfect conditions for those Americans wealthy enough to invest in stocks and other assets. By keeping inflation low, it delays the start of rate rises by the Federal Reserve; and it stimulates an economy that appears to need a stimulus.
Friday’s jobless numbers for October, with the unemployment rate reducing to 5.8 per cent and the work force growing a little, but average earnings remaining flat, only accentuate that trend: great for asset prices, but not enough to leave most Americans feeling better off.
The discontent Americans showed in the midterm elections this week was wholly understandable. If it is any consolation, cheaper oil will make their wages go further, while putting ever more pressure on resource-producing emerging markets, and pushing up the dollar. Cheaper oil is part of a world that is very comfy indeed for Americans.
john.authers@ft.com |
