Oil Plunge: Good for Retail, Bad for Earnings?

Friday, January 12, 2007 | 07:26 AM

After starting the year in a funk, Markets have rallied on Crude dropping to 19 month lows.

Spx_ex_energy_20070110204023 Dropping oil prices are a double edged sword: They help consumers, especially those on the low end, who have been squeezed by higher gasoline and home heating oil prices. And retailers, who posted a rather disappointing holiday sales season, could use any good news they can find (especially Wal-Mart).

But falling oil hurts energy companies, who have been outsized contributors to double digit earnings growth of S&P500. Indeed, as Justin Lahart noted yesterday, the "less energy companies earn this year, the more expensive the rest of the stock market might look."

Consider the energy complex' contributions to S&P500's reasonable P/E:

"Energy shares may be able to weather a slowdown [in oil prices]. As much as the stocks have risen in recent years, earnings have risen more. As a result, energy shares have rarely looked so cheap. They're trading at 9.8 times estimated 2006 earnings per share, according to S&P. Three years ago, the price-to-earnings ratio was 13.7.

If it wasn't for the rather cheaply valued energy companies and their robust earnings, the overall market might not look so cheap. Take away the energy sector, and that P/E skips up to 17.3. By the same token, energy has provided an outsize portion of overall earnings growth. For 2006, estimated S&P 500 earnings per share look to be 56% higher than in 2003. Take away energy, and earnings grew by 44%.

In other words, if it wasn't for energy companies' contribution, the stock market would exhibit slower earnings growth and be more expensive. And this may be the year energy companies stop contributing."

I don't think equities on a P/E basis are cheap -- they are at historical fair value.

But that's the downside; The upside is:

"If lower oil prices lead to a reduction in what American consumers spend on gasoline, it would leave them with more money for all kinds of discretionary purchases, such as restaurant meals, movies and vacations. That spending could provide a welcome cushion for the U.S. economy, which is grappling with a sharp downturn in the housing sector. It could also give a boost to airlines and auto makers, which have been hurt by high fuel prices . . .

Indeed, many economists credit the retreat of energy prices from their summer peaks for a recent bout of stronger-than-expected economic performance. Nonfarm payrolls in the U.S. grew by a seasonally adjusted 167,000 jobs in December, and economists expect inflation-adjusted consumer spending to have grown more than 4% in the fourth quarter of 2006. That has led some to raise their estimates of inflation-adjusted GDP growth in the fourth quarter to an annual rate of more than 3%, compared with forecasts of about 2% just a month ago.
"

Even though Oil has fallen 33% from its Summer peaks, gasoline is selling at only a penny less than it was in December (according to AAA).

Don't fret: Gasoline at Retail takes much longer to drop than does Crude Oil. (If you want to know why, read "Why is it that Gasoline Prices seem to rise so quickly, but fall so slowly?") The short answer is its a function of competition by service stations, who are less timely in price changes than say the futures markets. As long as Crude keeps falling (or even just plateaus), Gas prices will eventually follow.

From a macro-perspective, the key question is this: Will the bump in retail sales/profits will be able to offset the earnings decrease in energy companies?

Stay tuned . . .



Oilex_20070111210912



Sources:
Energy Stocks May Lack Fuel To Help Market
JUSTIN LAHART
WSJ, January 11, 2007; Page C1
http://online.wsj.com/article/SB116847676976873215.html

Rapid Plunge In Price of Oil May Fuel Growth
Though Still Expensive, Crude Has Fallen 33% From July's Record High
MARK WHITEHOUSE, ANN DAVIS and BHUSHAN BAHREE
WSJ, January 11, 2007 11:26 p.m.; Page A1
http://online.wsj.com/article/SB116855866186974495.html

Friday, January 12, 2007 | 07:26 AM | Permalink | Comments (17) | TrackBack (0)
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Comments

It wasn't that bad a season for retailers, judging by the Commerce Department data. Goldilocks lives! and investment banks are now speedily revising up their Q4 GDP forecasts to a 3 handle, e.g. trend.

Posted by: Macro Man | Jan 12, 2007 8:38:40 AM

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