Just like I took the “over” for the Wildcats (70 points) when Arizona faced Illinois in the NCAA Tournament Elite 8 last weekend, I’m going to take the “over” again on the number of energy stocks Goldman Sachs (GS) owns. Today’s $1+ jump in crude prices is being attributed to Goldman’s bullish note today that they see a “super spike” in oil prices on the horizon. Previously, GS had said they thought oil could hit $80 per barrel in such a scenario, but that number was lifted to $105 today, sparking much conversation on the Street.
Call me crazy, but I think the Goldman call had more to do with boosting the stocks they own, rather than some meaningful change in oil fundamentals they saw change overnight. After peaking at $57 or so, oil futures fell $5 fairly quickly in March, leading to a correction in the sector’s shares. By raising their already overly bullish view, this slide would quickly turnaround, stopping the losses from their energy holdings and allowing them to unload some stock at favorable prices if they were so inclined.
Everybody is talking about oil and a potential double-top after the commodity failed to break through $55 a barrel in yesterday’s trading. Nobody can really predict these short-term movements, and enough people look at charts that we might not see $60 near-term. Even if we get a pullback in oil prices on technical trading, I doubt that is the end of high oil prices. Any meaningful pullback should be bought as far as the energy stocks are concerned, just as a run above $55 presents a good opportunity to take some profit off the table.
High oil prices are here to stay, contrary to many people who blame the current escalated priced to hedge fund trader speculation. We might not see a run to $60 this week or next, but I would not be surprised if we saw oil hit $60 before it drops to $40 per barrel. When picking stocks in the group, focus on those companies that not only do well with prices high, but will have strong production growth as well, so when prices do give back some ground, their earnings won’t collapse.
The Dow staged a late day rally today, closing up 75 points to 10,750, despite the fact that oil prices have once again cracked through $50 per barrel. Many would expect that with oil at $51.39, stock prices would have suffered. After a 170-point Dow drop on Tuesday (oil soared more than $2 that day, to over $50), we have recouped most of those gains already without a pullback in the oil market.
From this, we see that the relationship between oil and stock prices can get pretty interesting. Many economists hate to see increasing energy prices, fearing it will cripple any moderate economic growth we do have in this country. They see higher gas prices at the pump as an indirect tax on consumers, curbing their disposable income. Since the consumer represents two-thirds of the U.S. economy, stock prices generally falter when gas prices head higher.
While I won’t argue there is some connection, I have long thought that the impact higher energy prices have is somewhat exaggerated. After all, if the average consumer fills up his or her 15 gallon tank once a week, a 25 cent increase in the per-gallon price of gas costs that person about $195 per year extra. Hardly insignificant, but not enough to cripple an economy by any means, in my opinion.
Another interesting thing is how energy prices are affecting corporate earnings. While many will make the case that high gas prices will hurt the profit of consumer-related companies, earnings estimates have actually risen since the beginning of the year, even though oil prices have gone up as well. Growth in earnings for the S&P 500 was initially expected to be in the 7 to 8 percent range in 2005. Estimates have creeped up to between 9 and 10 percent already in the first two months of the new year. This has mostly been driven by the energy sector, whose profits are through the roof, and show no signs of slowing down.
As a result of higher profit estimates and a stock market that is down 1% thus far in 2005, the forward P/E on the S&P 500 has fallen to 16.2 or so. With the 10-year bond only yielding 4.29%, investors probably feel pretty comfortable buying stocks at these prices. The risk of course, is that energy prices fall meaningfully from here. The stock market might react postively to that initially, but don’t forget that such a move will lower corporate profit estimates, leaving stocks relatively more expensive than they are now.
Think back more than a year ago. At the time, market predictions for the coming year centered around one major theme; interest rates. The consensus opinion was drilled into our heads for months, namely that interest rates would have to rise in 2004, and the housing market would cool off. Some even called for the bursting of the housing bubble, even though there wasn’t a bubble at the time that could be burst. Investment strategists warned their clients to avoid stocks of mortgage lenders and home builders.
Believe it or not, the consensus for 2004 was wrong (okay, this is very believable). Despite the fact that the Fed did start raising their lending rate from 1% to 2%, market rates didn’t budge. In fact, in many cases they actually dropped. Mortgage rates were steady, and bond rates fell. What were some of the best performing stock groups in 2004? You guessed it.. mortgage lenders and housing stocks.
Okay, so that is in the past and just serves to prove that the consensus is usually wrong. With 2005 having just begun, what was everyone saying just before year-end, and how can we bet against it this year? Without a doubt the 2005 theme that received the most airtime was oil. After falling from its peak price of $55 per barrel, oil was hovering in the $40-$42 range at year-end 2004, and most were predicting a drop back to a “more normal” $28-$35 per barrel price tag.
So here we are, on January 18th and oil prices hit $49 this morning, knocking on the door of $50 for the second time in recent months. A move down to the high twenties or low thirties would surely ignite the market a bit, and the airline stocks even more dramatically, but don’t count on it. Oil is to 2005 what interest rates were to 2004.