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By Chris Puplava

In many parts of the country gasoline prices are over $4/gallon and consumers across the nation have taken note of the recent spike. Not surprisingly, there's also been a surge in news articles suggesting the economic recovery and market advance will soon stall based on current oil and gas prices. However, the key to identifying such a tipping point, is not the absolute price level but a sharp spike in energy prices over a short time period, i.e. the rate of change.

It is because the recent rise has not reached "shock-like" magnitude that current energy prices are unlikely to reverse economic and market trends. To explore this claim, there are a number of key data points I will cover below: the average rate of change in gasoline prices over time, number of news citations related to "oil prices", consumer trends, and market breadth.

Energy Seasonality Suggests Rise Is Normal

Gasoline prices rise throughout the first half of the year as the summer driving season approaches and then spend the latter half of the year falling.

As shown below in a seasonal chart of gasoline prices, while we are currently above the 5-year high for this time of year, the overall path doesn't yet exhibit any significant deviation.

click to enlarge

gasoline seasonality 2011-2012
Source: Bloomberg

While gasoline prices have hit $4/gallon early on in the year, they also entered the year at higher levels than in previous years and the annual rate of change so far is not of out the ordinary.

Over the last five years the peak in the annual rate of change (ROC) for gasoline prices usually occurs near the end of May to early June at roughly 27% whereas the current annual ROC in gasoline prices is still well below that level with a current reading of 14%.

If gasoline prices rise close to the normal annual ROC in May of 25%, given the $4/gallon level seen in May of 2011, that would correspond to $5/gallon gasoline this summer. Again, even if we hit $5/gallon gasoline by summer this would still be entirely normal in terms of a seasonal annual ROC.

gasoline rate of change yoy

Source: Bloomberg

The important point to remember is that consumers adapt and they can absorb gradual and normal price changes; it is the rapid and abnormal price changes that cause consumers to pull back. For example, who is currently freaking out about movie tickets that cost more than $10 or stamps over $0.40?

If the recent rise in oil and gasoline prices was such a shock we would see this reflected in the media. Sure we are seeing more news stories, but nothing like what was seen in 2008 or 2011 - the two most recent energy shocks. The figure below highlights the weekly news stories in Bloomberg that had "oil prices" within them. As you can see, we are nowhere near previous levels of alarm.

bloomberg news story count
Source: Bloomberg

Market Indicators Also Suggest We've Yet to Witness a True "Energy Shock"

The current worry for investors is that the rise in oil and gasoline prices will hurt the consumer and cause a retrenchment in spending. Given consumption makes up more than 70% of the economy, this is certainly a valid concern but if US consumers were retrenching would the S&P 500 Retail Index be at an all-time high?

s&p 500 retailing index
Source: Bloomberg

The reason I bring this up is that the market often provides excellent early warnings as to when we reach a tipping point with high energy prices and so monitoring various sector relationships can give investors insight into when to expect a consumer retrenchment and thus an economic slowdown.

To illustrate this point, monitoring the consumer discretionary sector relative to the energy sector not only highlights when we reach an energy tipping point, but also reveals this information well before a major market peak.

A perfect example of this was the situation in 2007 in which oil prices (USO) bottomed and then nearly doubled over the course of a year. Again, energy shocks constitute rapid increases over a short time period, and a near doubling in price over twelve months would certainly meet this criteria.

The energy shock of 2007 clearly played out in the stock market as the consumer discretionary sector relative to the energy sector (red line in top panel below) began a steep decline right as oil prices bottomed (lower panel below) and began a steep incline. Also of note, the peak in the consumer discretionary versus energy sector occurred more than six months before the stock market peaked (S&P 500 black line in top panel) and provided an early warning that inflationary pressures would take their toll on the economy and stock market.

spx 31 dec 2007
Source: StockCharts.com

A more recent example occurred last year where we witnessed the same dynamic of rapidly rising energy prices perfectly coinciding with the consumer discretionary sector's poor relative performance. Like 2007, the peak in the consumer discretionary sector relative to the energy sector occurred well before the peak in the stock market as did its bottom later in the year which occurred prior to the market's October 2011 bottom.

spx 30 dec 2011
Source: StockCharts.com

Flash forward to today and despite the rise in oil and gasoline prices the consumer discretionary sector relative to the energy sector is hanging in there and more or less trading sideways. Once the relative performance between the two sectors drops off sharply that will be the time to worry, but that time is not now.

spx 1 mar 2012
Source: StockCharts.com

A quick look at market internals for the S&P 500 (SPY) also shows that the negative affect of high energy prices are not causing any pain yet. If gasoline prices were set to stall the economy and stock market we wouldn't be witnessing an all-time high in the S&P Retailing Index and the consumer discretionary sector would not be the market's strongest sector.

Shown below are the percentage of stocks within each sector that have made a 52-week high over the last month and, wouldn't you know it, the consumer discretionary sector is the strongest with 44% of its members making a new 52-week high in the last month. (Interestingly enough, the energy sector is one of the weakest sectors with only 16% of its members making new 52-week highs in the last month.)

Regardless of looking at specific sectors, just look at what the message of the following chart is telling us where 26% of the 500 stocks within the S&P 500 have made a new 52-week high in the last four weeks. Outside of the telecommunications sector (which only has 7 members) every sector has good participation with the percentage of their members hitting new 52-week highs in double-digit territory.

52 weeks high market sectors
Source: StockCharts.com

Equally important is the lack of downside participation of stocks hitting new 52-week lows. If energy prices were significantly impacting the economy we would also see stocks rolling over and making fresh 52-week lows.

Look at the figure below and how it is the polar opposite to the new 52-week high figure above. Only 1% of the S&P 500 has made a new 52-week low over the last month. I submit that while the threat of an energy shock remains possible, particularly with Iran, the message of the market is clearly saying this is not impacting the market nor economy as of yet.

52 week highs utilities
Source: StockCharts.com

Summary

While high energy prices could certainly derail the economy and stock market ahead, investors should not run for the hills as the fingerprints of an energy shock are clearly absent as of now. That said, the threat of a shock is real and I would suggest watching three indicators to gauge this threat ahead which have all been highlighted above. They are the following:

  • The absolute price level of the S&P Retail Index (XRT)
  • The ratio of the consumer discretionary sector to the energy sector (XLY)/(XLE)
  • Market statistics for new 52-week lows and highs
Source: Why Energy Prices Won't Shock The Economy - For Now