Sky-high oil prices pose yet another
obstacle to U.S. corporate earnings, and some on Wall Street are worried this
could sink stock prices even deeper into the red.
Brent crude has surged nearly 40% since the start of the year and stands at
$110.73 per barrel as tight inventories, rising demand and the war in Ukraine
keep prices near their highest since 2014.
Big retailers Target Corp (TGT.N) and Walmart Inc (WMT.N) have already warned
that oil prices are cutting into their bottom lines. Some investors worry that
the impact of oil prices may not yet be fully reflected in analysts' estimates
of other companies’ earnings and could deliver stocks another blow if those
estimates start to fall.
"On the surface, earnings remain strong, however surging energy prices may
begin to cut into margins through 2022," said Jason Pride, chief
investment officer, Private Wealth, at Glenmede.
The S&P 500 is down 21.1% year-to-date, on track for its worst first half
of any year since 1932, according to S&P Dow Jones Indices, as the Fed
tightens monetary policy in its fight against the worst inflation in decades.
Overall, every $10 increase in the price of oil cuts 0.3% from global gross
domestic product, according to Ned Davis Research. The roughly $30 increase in
oil prices since February has shaved 1% off the global economy, LaForge
estimates, leaving the United States on a likely path toward recession this
year.
"There's no way to avoid it," said John LaForge, head of real asset
strategy at Wells Fargo Investment Institute. "When commodities do real
well you almost always find stocks are stuck in a bear market because they're
squeezing their margins."
Last month, Walmart said fuel costs were $160 million more than expected, while
Target said it was adding $1 billion to its forecast for transportation and
freight costs for the full year.
Still, there are few signs analysts are incorporating rising fuel costs into
estimates. Approximately 61% of corporate pre-announcements of second-quarter
earnings results have been negative so far, well behind the 68.7% rate of
negative pre-announcements for the prior quarter, according to Refintiv data.
Most S&P 500 companies will report second-quarter earnings after mid-July.
Overall, the S&P 500 is expected to post 5.4% earnings growth in the second
quarter, according to Refinitiv. Once energy companies are taken out, though,
that falls to a 2.2% decline.
Investors indicate they expect oil prices to stay high. Bullish positions in
oil and other commodities are the most popular trade among global investors,
according to a survey from BofA Global Research.
A Reuters poll showed analysts expect crude oil prices to end the year at
$99.52 a barrel and average $91.59 over the course of 2023. /CEPOLL The price
of oil has risen above $90 per barrel for a total of 22 months out of the last
10 years, while mainly trading in a range between $40 and $80, according to
Refinitiv data.
Analysts at BlackRock are among those warning that consensus earnings estimates
do not appear to reflect the possibility of energy prices hitting growth. That
is one reason "we don’t see the risk asset retreat as a reason to buy the
dip – and expect more volatility ahead,” they wrote this week.
Typically, high oil prices can slow the economy and eventually reduce demand,
either through a recession or a change in consumer spending habits. That seems
less likely this time around if Russia continues to face energy sanctions for
the foreseeable future, said Francisco Blanch, commodities strategist at BofA
Europe.
"Even if the world goes into recession, we estimate Brent could average
more than $75/bbl in 2023," he said.
This year's decline in the S&P 500 has so far largely been due to dropping
valuations rather than falling estimates, as investors have focused on the
Fed's aggressive response to inflation, said Garrett Melson, portfolio
strategist with Natixis Investment Managers Solutions.
Elevated oil prices will soon cut into earnings overall, eventually adding to
the appeal of large technology companies that do not rely on broad economic
gains like Google-parent Alphabet, he said.
"There's a real risk to margin compression and further downside from
here," he said.
Source: Reuters