This commentary originally appeared on Real Money Pro at 9:07 a.m. ET on Wednesday, Dec. 8. Click here to learn about this dynamic market information service for active traders.
-- Federal Reserve chair Janet Yellen, December 2014
This year started with a strong consensus view, as expressed in Janet Yellen's comments above, that lower oil prices would serve almost like a massive tax cut for consumers, boosting the economy and stimulating corporate profits.
Oil vey! Were they wrong!
- A year ago, consensus 2015 earnings-per-share forecasts for the S&P 500 were above $130 a share. Now, the consensus is about $113. A good portion of that decline stems from reduced expectations for the energy sector, which other sectors haven't offset.
- Retail spending disappointed throughout 2015. Indeed, the retail sector has been a market landmine this year. Just look at what's happened to the earnings of Ralph Lauren (RL), Macy's (M), Bed Bath & Beyond (BBBY), Wal-Mart (WMT), and now Costco (COST).
- The BRICs (Brazil, Russia, India and China) are suffering from lower commodities prices, including oil. And they've have "exported" the resulting deflation, slowing economic growth and reduced profits.
- In a flat, networked and interconnected globe, We are the World. We're not an island of prosperity -- lower energy prices have caused a slowdown in world trade, and global economic growth has suffered.
- The transportation industry and U.S. port activity have both floundered as energy-related activity waned.
- Lower prices for energy and other commodities have caused global political turmoil, and have contributed to Mideast instability and rising geopolitical risks.
- The U.S. energy sector is suffering much worse than expected, as measured by unemployment, activity and profits.
- There has been much more collateral damage from lower oil than many predicted. Most importantly, the high-yield-bond market has fallen its lowest price since the 2011 European financial crisis under the weight of lower energy credits.
- Lower oil prices have wrecked havoc and caused many billions of dollars in losses to energy-related investments like MLPs and stocks of exploration-and-production companies.
- Airlines were supposed to be one beneficiary of lower oil prices, but shares of Southwest Airlines (LUV) dropped by 10% yesterday -- the worst performance among S&P 500 components. LUV tanked after the firm warned that operating revenue per available seat will likely fall this quarter.
As I begin to assemble my "15 Surprises for 2016" list, I want to focus on one of the most successful surprises that I highlighted for 2015.
It's been my long-held view that an energy-price drop wouldn't help U.S. corporate profits or global economic growth on balance. Here is, in its entirety, my forecast from April on how lower energy prices would have an ambiguous impact in 2015:
On Fast Money Halftime my friend/buddy/pal BTIG's Dan Greenhaus remarked that ex-energy 1Q 2015 profits will be up slightly year over year.
I agree with Dan.
But wasn't the consensus view that the collapse in oil prices would add to corporate profitability, especially when petroleum products serve as raw materials?
So shouldn't that modest improvement in non-energy corporate profits be seen as DISAPPOINTING?
And I would add, strategists didn't adjust S&P profits when oil was $110 a barrel, did they?
One of my Surprises for 2015 was that the much-lower-price of oil would not have an incremental positive impact on the domestic economic recovery this year.
Here is my outlier view on the relationship between economic growth and oil prices:
Despite a nearly universal view that oil prices will be a net benefit to the U.S. economy, I continue to believe that the benefit remains ambiguous. Retail spending and overall economic activity remain subdued, despite lower oil prices.
Two weeks ago, Peter Boockvar wrote this:
February retail sales ex gasoline and volatile auto's unexpectedly fell by .2%, well worse than expectations of up .3% and January was revised down by three tenths. The 'control group' sales, which also takes out building materials, saw no growth m/o/m and January was revised down by two tenths. The estimate was up .4%. Sales fell m/o/m for autos, furniture, electronics, building materials, health/personal care, department stores and restaurant/bars. Gains were seen for online retailers, sporting goods and food/beverages. Sales of clothing were flat after two months of declines and thus haven't grown since November. Bottom line, sales ex gasoline station sales on an absolute basis are at the lowest level since September. The belief that lower gasoline prices (down 30% y/o/y) were going to spur a large pick up in spending on other goods just hasn't happened. It's been saved, used to pay down debt, used for higher food and rent or property tax costs (to name a few higher costs of living) and possibly is being spent on services, such as healthcare (thanks to Obamacare) which has been the biggest source of growth in services spending. I'm not going to use weather as an excuse as its winter and the data is seasonally adjusted. Retail stocks are trading at near all time record highs but we've now seen three months in a row of disappointing retail sales as measured by this report. If retail stocks are looking forward, then hopefully they see quicker wage growth coming soon.
A month ago, I continued to question the benefits of lower oil prices.
I have argued that the net benefit of much lower prices for energy products is ambiguous.
We see this in the weakness in certain regional manufacturing data (e.g., the Dallas Fed's manufacturing index), in the rig count contraction, in the jobs market (e.g., job count and wages) in energy dependent states, in stagnating housing activity, in a plunge in energy-related capital spending, in a weakening high-yield market, and in a (likely) meaningful subtraction ($5/share to $7/share) in 2015 S&P forecasts.
We have yet to see the benefit of lower oil prices in retail spending or in automobile industry sales.
If lower oil and gas prices are anticipated to catalyze domestic economic growth, why is the yield on the 10 year U.S. note still around 1.75%?
And we have yet to see the exposure of commodity-linked notes in the financial community.
The entirety of the Sell Side on Wall Street as well as the Buy Side keep telling us low oil price is good for the economy (and by abstraction earnings and the stock market). BUT the market rips every time market blips up (the last two days), and sells off when the price of oil goes down.
The lesson: Watch what they do, not what they say!
Lower oil prices, negatively impacting economic growth in the U.S.? Inconceivable!
Here you go:
Surprise No. 3 -- The drop in oil prices fails to help the economy.
"In its November 14, 2014 Daily Observations ("The Implications of $75 Oil for the US Economy"), the highly respected hedge fund Bridgewater Associates, LP confirmed that lower oil prices will have a negative impact on the economy. After an initial transitory positive impact on GDP, Bridgewater explains that lower oil investment and production will lead to a drag on real growth of 0.5% of GDP. The firm noted that over the past few years, oil production and investment have been adding about 0.5% to nominal GDP growth but that if oil levels out at $75 per barrel, this would shift to something like -0.7% over the next year, creating a material hit to income growth of 1-1.5%." -- Mike Lewitt, The Credit Strategist
Despite the near-universal view that lower oil prices will benefit the economy, the reverse turns out to be the case in 2015 as the economy as a whole may not have more money -- it might have less money.
Continued higher costs for food, rent, insurance, education, etc. eat up the benefit of lower oil prices. Some of the savings from lower oil is saved by the consumer who is frightened by slowing domestic growth, a slowdown in job creation and a deceleration in the rate of growth in wages and salaries.
And the unfavorable drain on oil-related capital spending and lower-employment levels serve to further drain the benefits of lower gasoline and heating oil prices.
In The Financial Times, recently, Martin Wolf wrote: "(A) $40 fall in the price of oil represents a shift of roughly $1.3 trillion (close to 2 per cent of world gross output) from producers to consumers annually. This is significant. Since, on balance, consumers are also more likely to spend quickly than producers, this should generate a modest boost to world demand."
But Wolf, and the many other observers, as Mike Lewitt again reminds us, "fail to explain how the $1.3 trillion that has been deducted from the global economy is able to shift from one group to another."
I will stick to my thesis.
My buddy/pal/friend Byron Wien of Blackstone offers an opposite view to mine on the ramifications of lower oil prices."
-- Doug's Daily Diary, Ambiguous Oil (April 2, 2015)