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Oil Bust Puts Stocks On Sale

By Benjamin Shepherd on February 18, 2016

The stocks have been taking some pretty wild swings lately that seem random. There’s been one pretty good indicator as to which way the markets will break on any given day: oil prices.

When the markets thought Russia and OPEC were close to cutting a deal on a production quota last week, oil broke sharply higher and so did stocks. On days before that when the storage reports emphasized the glut of oil on the market, oil and stocks broke lower. It isn’t exactly a one-for-one correlation, but it’s about the closest I’ve ever seen.

There are legitimate reasons for investors to follow oil prices so closely. For one thing, sagging oil prices are often a sign of sagging demand, which can be a harbinger of recession. As Richard pointed out in last week’s Income Without Borders, low oil prices are also weighing on bank stocks as investors worry about imploding loans in the energy patch. Add in the countries that rely on oil exports to support their economies and the companies in the energy patch losing their shirts, there are plenty of reasons to worry.

That is, except for the fact that oil is down not so much because of slumping demand, but surging production.

High oil prices and technological advances drove the fracking revolution here in the U.S., driving our domestic production to record levels. We were pumping so much oil Congress actually ended the ban on oil exports last year, with the first shipments of crude leaving U.S. ports for Europe back in January.

I hate to frame things in such simplistic terms, but the Saudi’s and other Middle Eastern oil producers weren’t happy about that development. Eager to hang on to their market share, cutting production wasn’t an option since that would just drive oil prices higher, encouraging more U.S. production. They kept on pumping instead, driving prices down to levels where American frackers couldn’t make a profit, producing a slight decline in U.S. production and severely denting earnings for American producers.

Demand, on the other hand, has held relatively steady despite the slowing economic growth in China. In fact, in its latest energy outlook, BP (NYSE: BP) predicts average annual energy demand growth of 1.4% over the next two decades. While that’s not as strong as it has been in year’s past, that’s still not too shabby.

So rather than presaging a recession these plunging oil prices are actually a pretty classic price war.

Considering that energy only makes up about 3% of the U.S. economy but pretty much all of us are at the mercy of gasoline prices, this price war could actually be to our benefit. Every dollar not spent on a gallon of gasoline is a dollar that can be spent elsewhere (or invested in one of our Global Income Edge stocks), which we’re seeing in fourth quarter earnings.

With earnings season in high gear, most of the reports so far have been pretty encouraging. Most companies that aren’t either heavily exposed to the energy sector or to swings in the U.S. dollar are reporting solid growth. According to data from FactSet, of the 76% of S&P 500 companies having reported earnings so far, 69% have reported earnings above estimates and half have beaten on revenue. That came in a fourth quarter when holiday shoppers were more subdued than usual. That doesn’t sound like a recession to me.

So yes, there are weak spots in global growth which could potential ding energy demand, but they aren’t having a huge impact yet. Yes, energy prices are weak, which is hurting market sentiment, but that’s the result of a price war which ultimately benefits consumers. So we’re not staring down another recession so much as having a stock buying opportunity handed to us on a silver platter.

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