After starting the year in a funk, Markets have rallied on Crude dropping to 19 month lows.
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 . . .
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
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.
Let’s suppose we get a stimulus from oil prices declining. Laffer was on Kudlow last night predicting that all commodities will continue to decline pretty dramatically. He even claimed oil may reach $25.
Let’s further suppose that housing does worsen. Without some other economic engine to offset the negative effects of a housing shortfall, the Fed would be likely to cut rates, and the regulators might be more likely to abandon their more circumspect oversight of lenders.
But… if retail does get a boost (just as I’m writing, retail sales have been reported generally ‘better’), the Fed and housing regulators may both be able to hold their present courses.
numbers are strong consider the credit card usage up strong last month, with lower gas , hearting cost … yeah retail sales should be strong.
Is 0.9% retail sales growth in December considered “good”? Or as Chris Rock might say, are we “low expectation havin’ [expletive deleted] [expletive deleted]s”?
10.8% annualized is pretty punchy, particularly when gift cards are probably not seasonally adjusted.
Per BR:
“I don’t think equities on a P/E basis are cheap — they are at historical fair value.”
…end quote.
—
I don’t so much in general argue with you about that statement, although I still think historical P/E multiples are somewhat lower.
I’d like for you to do a whole topic on this and attempt to gather any and all resources that could better peg what historical values truly are.
The reason this is so important is that, at these currently lower P/E multiples, fractional and whole P/E units represent larger potential changes in market levels.
I’m not sure I’d know perfectly who to credit my own views to, but my concept of historical average P/Es puts the figure somewhere in the neighborhood of a range from about high 13s to high 15s.
Accordingly, that would put a current 17 into an overpriced status of possibly 1-3 P/E units… or about 5-18% overvalued still.
I haven’t even raised the subject of where declining P/Es typically finish the drops after robust declines.
BTW, anyone who now wants to respond to my comments with an optimistic view of why P/Es don’t matter, start by telling me why they’re not 20, 22 or 23 anymore.
Since late 1999, earnings have advanced ~ 70%. Cost of capital has dropped ~ 30% (10 yr treas). PE’s have obviously contracted. More importantly the total market cap has dropped over the last year ~3%, even thou it had a nice move up. Supply and demand (liquidity vs shrinking pool of equities) will force an expansion of PE’s. Does a PE matter? Sure, but if you want to make money, see beyond this one metric, and see that many quality large cap equities have to play catch up with their earnings. Further, we can mostly agree that the headwind of the Fed is probably through. Take another look at a 1996 chart. This is a do over, imho.
“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).”
That’s odd, because even though gasoline has fallen 25% from its summer peaks (according to AAA), oil is selling at only a few dollars less than it was in December.
Numbers are strange things!
Retail Sales strong? Nope, they aren’t. The private sector doesn’t agree. The government is again found to be incorrect. Sorry, what is, is.
I don’t respect this government nor their pathetic attempts at “numbers” they can’t understand.
I don’t see how you can call the December numbers weak. I also don’t see how you can call them punchy. “Trend” is probably a safer description. Per population, year-over-year real sales for the last third of aa year have been sitting right around the averages, going back a decade and a half.
Trend consumption probably does mean close to trend production. Ceteris paribus, construction and autos might drag that down to a 2 handle, but the deflator likely will come in lower than it had, which will pull it up again. Do I hear mid/high 2s?
Because the “trend” is weakness over the previous 2 years. With layoffs starting in housing and related to housing(oh yes, they have baby and even government stats won’t be able to deny that in February and March when the house comes through).
You are underestimating the loss in residential investment and the pretty stagnent business side of it. The key kicker is the overestimation of auto-production in Q3 which must come out of the following figures. Take that inventory may be down in Q4, you get a ugly quarter, but not recession yet(maybe even a temporary rebound in Q1). I don’t believe that begins to the May-September timeframe when the intial layoffs from the housing busts are mostly on the street.
This “strength” you are talking about doesn’t exist.
I should also add, if the government hadn’t “revised” down in November, retail sales would have been .5%. This is just dishonesty from the government.
My advice to the Census Board and the BLS is this: begin to report honestly or face possible removal of your functions by the Democrats, because they will move IMO sometime over the next 2 years, to take away those functions and completely revise where the US economy, where it has been, where it is now and where it is going for the future.
The more non-governmental sources whine, the more people will start to call for removal as well. Lately, these “institutions” have given some numbers that simply do not add up.
Comstock Partners analysts note that oil isn’t alone in its decline – the CRB commodity index is down 22% since May. “According to ISI, since 1974 every decline in the index of 20% or more has been associated with a recession, a significant slowdown or a financial crisis,” they write in weekly commentary. “Each of these periods has also occurred following a period of tight money and an inverted yield curve. In this regard it is also noteworthy that oil has not been the only commodity declining in price.”
Yes, all those markets were inflated by hedge funds levering up a crowded speculative trade. When oil hit $80, we had RECORD oil inventories…no room in the ground to put it. Tankers sat at the docks full, as there was nowhere to put the stuff. The market hung on every breath from T Boone.
This is the other side of that trade, as opposed to a recession signal, imho.
This is the other side of that trade, as opposed to a recession signal, imho
But it isn’t the only commodity making the signal. Granted their was a bubble, but weakness in December was quite evident in the global economy, whether anybody wants to admit it or not.
Weakness, I agree….just not a recession.
China is slowing down to ~ 10% growth. ;o)
Have a good weekend.
Fred, it is the weakness that leads to recession whether this March or the March 2008 like Goldman seems to indicate.
The 80’s housing bust actually started in 1987 though nobody even gets that point.
If someone says something as stupid as this, “the less energy companies earn this year, the more expensive the rest of the stock market might look.” please don’t give it any space. Maybe the ‘whole stock market…..” but not the “rest of the stock market..”.