Like most of you, over the last year or two, I had considered seriously the consequences of rising North American oil production on global oil prices. In response, I held not one energy share in my portfolio.
As recently as early October, I was still in the camp of ‘range-bound’ oil trading between $90 and $100. In my monthly strategy reports to the Zacks trading community, that’s what I wrote each month.
What happened? Three to four years of range-bound $90 to $100 a barrel WTI oil prices delivered a highly profitable economic landscape. With a fully loaded oil cost falling between $40 to $65 a barrel, North American shale oil production got rolling.
Now, Saudi oil at a fully loaded $10 a barrel in cost, is fighting back.
For sure, this has raised more questions than answers. Now is the time to get the conversation going.
Question One: With oil & energy stocks already under pressure, can falling oil prices derail a Santa Claus Rally?
S&P 500 sector strategists have indeed cut Energy sector EPS estimates by just below -10% in the last month, and Materials sector EPS estimates by just below -4%. This took the overall look to S&P 500 earnings down from $133 to just below $130. That’s a -3% cut to overall earnings.
The other part of the analyst revision story? It lifted apparel earnings estimates for Skechers (SKX), leisure estimates for Nintendo (NTDOY), home furnishing-appliance estimates for Leggett & Platt (LEG), retail estimates for Pantry (PTRY) and electronics estimates for LG (LPL) in the Consumer Discretionary space. It also helped the transports like Ryder (R) and Southwest (LUV) in the Industrials.
In terms of a Santa Claus rally, though, the fair value of the S&P 500 fell from around 2070 to 2000 with the Energy and Materials cuts.
Bottom line: we most likely have seen 95% of the Santa Claus rally already. I don’t see the S&P 500 falling below the 2000 index level by Xmas, but it could be flat until then. I think 2100 is the top end.
Question Two: Since global demand is still present and accounted for, will further weakness in the price of oil only help to stoke more demand across the board — as it widens profit margins on a range of industries?
The short answer is YES. Demand in regions of the world that import oil is being stoked. This means consumers and companies based in China, Japan, Europe and India benefit the most. These areas of the world get a new Xmas lift to their stimulus needs.
All of the above mentioned regions were already in the process of providing lots of monetary stimulus. Every $10 a barrel fall in the oil price is 25 basis points in effective easing by a central bank. That means $30 lower oil is 75 basis points of effective monetary easing. Lower oil prices also lower both consumer and producer price inflation. That means the core central bank mandate to keep inflation under check has gotten easier, across the board.
The bottom line? The Saudis like to take care of their market share, AND they like to take care of their key customers.
This Saudi price cut should directly stoke demand for consumer sectors, industrials and IT sectors across the global landscape. The Financials will benefit in a second stage — from the consumer and business lift in demand provided by their oil price cut.
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