Tuesday, January 6, 2015
Oil prices are again in the spotlight and weighing on market sentiment, with the commodity’s problems seen as reflecting the health of the global economy. The oil development is also having an impact on earnings, with the sharp decline in oil company estimates showing up in the aggregate earnings picture as well.
The decline in oil prices is a net positive for the U.S. and world economy and as such should be pushing stocks higher, not the other way around. The reason market participants find plunging oil prices unnerving is the read-through this pricing action provides about the global economy. As discussed in this space in recent days, the current oil price decline isn’t just a function of increased shale oil supplies from the U.S., but also reflective of soft demand resulting from global economic weakness.
We have been aware of the uncertain outlook for the global economy for quite some time, with Europe fighting deflation, Japan still struggling and China losing steam. In fact, the improving outlook for the U.S. economy is in contrast to the same for all its trading partners. That is the reason why U.S. monetary policy is moving in a different direction from what is expected elsewhere among the major world economies. The resulting strength in U.S. dollar has been a contributing factor to the oil price decline.
As I mentioned, it is oil’s role as a proxy for the health of the global economy that gets markets concerned. Recent lowered projections for global oil demand growth by regulatory and oversight agencies and soft economic data from Europe, China and elsewhere magnify this issue. The issue is particularly acute for Europe, where Greece’s political instability and heightened risks of exit from the currency union have added to existing deflation worries. Given the Euro-Zone’s status as an oil importing consumer, the region will be a net beneficiary of the commodity’s decline in the long run. But the sharp price drop adds to the near-term deflationary trend.
The oil price drop is having a big earnings impact as well that will become evident as the Q4 earnings season unfolds in the coming days. The extent of negative revisions that we saw for Q4 in the last three months has been the highest that we have seen in the run up to any reporting cycle in more than a year, with declines in Energy sector estimates the biggest driver of this outsized drop. In fact, roughly 45% of the decline in aggregate Q4 estimates for the S&P 500 over the last three months came from the Energy sector.
You could see the extent of the sector’s negative revisions by looking at what happened to Q4 estimates for the sector’s three big players – Exxon (XOM), Chevron (CVX) and ConocoPhillips (COP). Consensus Q4 EPS estimates for XOM, CVX and COP are down -22.5%, -33.2% and -44.7% in the last three months, respectively. It is downright painful in the oil patch right now.
Sheraz Mian
Director of Research
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