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 per cent since the start of the year and stands at US$110.73 a barrel as tight inventories, rising demand and the war in Ukraine keep prices near their highest since 2014.
Big retailers Target Corp. and Walmart Inc. 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 per cent 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.
Over all, every US$10 increase in the price of oil cuts 0.3 per cent from global gross domestic product, according to Ned Davis Research. The roughly US$30 increase in oil prices since February has shaved 1 per cent off the global economy, estimates John LaForge, head of real asset strategy at Wells Fargo Investment Institute, leaving the United States on a likely path toward recession this year.
“There’s no way to avoid it,” Mr. LaForge said. “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 US$160-million more than expected, while Target said it was adding US$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 per cent of corporate preannouncements of second-quarter earnings results have been negative so far, well behind the 68.7-per-cent rate of negative preannouncements for the prior quarter, according to Refintiv data. Most S&P 500 companies will report second-quarter earnings after mid-July.
Over all, the S&P 500 is expected to post 5.4-per-cent earnings growth in the second quarter, according to Refinitiv. Once energy companies are taken out, though, that falls to a 2.2-per-cent 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 US$99.52 a barrel and average US$91.59 over the course of 2023. The price of oil has risen above US$90 a barrel for a total of 22 months out of the past 10 years, while mainly trading in a range between US$40 and US$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 US$75/bbl in 2023,” he said.
This year’s decline in the S&P 500 has so far largely been because of 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 such as Google-parent Alphabet, he said.
“There’s a real risk to margin compression and further downside from here,” he said.
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