Jubak's Journal
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Ask the Fed about a year-end rally
A nice move based on falling -- yes, falling -- oil prices is a possibility. But you won't see it if the Fed says it's really scared about inflation.
By Jim Jubak
For the rest of 2005, the stock market will be a battleground between hopes for lower oil prices and fears of higher interest rates. If oil prices fall, stocks -- in at least a few select sectors -- are likely to jump.
But that won't happen until the markets are through worrying about what Alan Greenspan & Co. will do and say about interest rates on Nov. 1. If the Fed signals that it is more worried about inflation -- and inclined to raise interest rates more aggressively in response -- I think we could see a decline that takes the major indexes down 5% to 10%.
That kind of a sell-off would be the signal to buy in anticipation of a traditional end-of-the-year rally.
A slower pace for oil prices
The price of crude oil looks like it has hit a temporary top. When the price for a barrel of crude (light, sweet crude for December delivery, to be exact) dropped below $63 last week, it broke the short-term uptrend for oil prices, according to Philip Erlanger, editor of the "Erlanger Squeeze Play" newsletter. Now that oil has fallen through technical support at $63 -- it traded below $61 on Monday -- it could well drop back to $55 a barrel.
The price of oil futures is also signaling a moderation in price increases. Back in mid-June, oil for September delivery was at $58.20 a barrel, according to the U.S. Energy Information Agency. At that time, the market clearly expected oil prices to rise and rise fast. A contract for December delivery was priced at $60.02 a barrel, almost $2 more.
That spread has narrowed in recent weeks, to 74 cents on Oct. 4. The energy market thinks oil prices will continue to rise, but much less rapidly. If you look even further out, the commodity market is forecasting flat crude oil prices in the second half of 2006, according to Bernstein Research.
While $55 may look cheap compared to recent highs near $70, it would represent a 27% increase in the price of crude since the beginning of 2005. That's good news compared to where we've been. At the end of September, crude oil was up 52% since the beginning of 2005. Knocking that change back to 27% would be a huge improvement. It would be even better if, by December, that change narrows down to 16%, as the futures market suggests.
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That's because its the speed at which energy prices are rising that has the most impact on consumer and corporate behavior. Given enough time, consumers will change habits, invest in energy-saving technologies, work more hours -- or go deeper in debt. And they'll keep spending. Companies will cut costs, improve efficiency and pass energy-cost increases along to customers -- or go deeper into debt. Thus, they'll compensate for higher costs, maintain profit margins and keep earnings growing at double-digit rates. The economy, still largely powered by consumer spending, will continue to chug along.
The stock market's split personality
Current Wall Street expectations, however, assume that quickly rising energy prices will ding third-quarter earnings. To understand how oil has created modest expectations on Wall Street, however, you have to divide stocks into two groups, energy and non-energy.
So far, 2005 has been a great year for energy stocks. Energy stocks in the Standard & Poor's 500 index ($INX) climbed 30% in the first three quarters of the year. It's been a crummy year for the rest of the market, and it's much crummier than the overall market indexes indicate. For the first three quarters, the overall S&P 500 index lost 1.7%. Take out energy stocks, which account for 10% of the index, and the loss is more than twice as large, 4%, S&P says.
It's the same story with earnings. On the surface, Wall Street is expecting another stellar quarter of earnings growth. Thomson Financial says analysts are projecting that earnings for the S&P 500 climbed 16.4% in the recently completed September quarter. That would be a healthy rebound from the 11.7% growth recorded in the second quarter.
If earnings are going to be so great for the third quarter, why hasn't the stock market been going up? According to Thomson, the energy companies in the S&P 500 are projected to grow earnings by 71% in the September quarter. Non-energy company earnings are projected to grow by just 10%. That would be even lower than the 11.7% earnings growth of the second quarter and provide solid evidence for those on Wall Street who argue that the economy is slowing.
The picture for the fourth quarter isn't any better. In fact, it's worse if you remember that the fourth quarter is historically the strongest of all the quarters of the year. That's because consumers and businesses concentrate so much of their buying into the end of the year. Wall Street currently projects S&P 500 earnings growth of 16.5% for the fourth quarter. That becomes projected growth of just 12.3% if you look just at non-energy earnings. Quite a comedown from the 19.7% growth in the fourth quarter of 2004.
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