Rising Energy Prices Will Suppress Retail Sales, Corporate Earnings & Summer Travel

By: William Patalon III

When U.S. Department of Energy analysts told you more than a month ago that gasoline prices would peak at about $4 a gallon around Memorial Day, we told you they were wrong. Gas prices, we said, were destined to head much, much higher.

Clearly, we were correct. Although gasoline prices have hit the $4 market in many places, this is hardly the peak. Even though gas prices rose for 14 straight days - a streak that ended last week - oil prices have continued their surge, as well, meaning prices at the pump still haven’t caught up with oil prices.

Here’s the question many are asking now: Will Memorial Day represent the peak in gas prices (not very likely)? Or will July 4th now become the new target date for those energy prognosticators?

With investors and traders alike returning from the long holiday weekend, oil-and-gas prices will remain high on their radar screens. For now, those "low supply/high demand" naysayers seem to be winning out over the "weak dollar/speculation" conspirators and gasoline prices in excess of $4.00 a gallon are now a fait accomplis.

Far in excess, in fact. Money Morning Investment Director Keith Fitz-Gerald, a longtime energy bull who first predicted triple-digit oil prices back in 2002 (a correct projection, as we know), is now predicting that oil prices will reach $225 a barrel within a just few short years.

New earnings releases this week will reveal how both discounters and high-end retailers are being impacted by both the sluggish economy and rising gas prices. Costco Wholesale Corp. (COST), Sears Holdings Corp. (SHLD) and Tiffany & Co. (TIF) all report, though investors increasingly seem to be welcoming such profit news with a collective yawn these days. Consumer confidence and personal income/spending give investors a more accurate view of the mindset of the consumer, who, after all, accounts for as much as 70% of the U.S. economy’s gross domestic product (GDP).

Investors also get a reminder of the weak first-quarter activity, with a revised the revised release of GDP (originally reported as +0.6%); since many analysts believe a buildup in inventories pushed the number up above where it should have been, the revised statistic could be much lower - meaning that renewed talks of a U.S. recession are sure to follow.

The Federal Reserve Bank of New York will host a conference at the Colombia Business School with New York Fed President Timothy F. Geithner and Donald L. Kohn, the vice chairman of the Fed Board of Governors, pontificating on money market issues (as well as other timely topics). Finally, with U.S. Sen. Barack Obama very close to wrapping up the Democratic presidential nomination, his policies on taxes, the economy, entitlements, drilling, globalization, and other key issues will be dissected much more now than ever before in the past.

Market Matters

Memorial Day 2008 could not get here soon enough for investors (or at least for the declining numbers of consumers who still could afford to take advantage of this long holiday weekend).

After a week of obsessing over gas prices, they can analyze how those (pessimistic) travel prognostications actually panned out. For 16 straight days, AAA reported record prices at the pumps with the recent average of $3.875/gallon getting dangerously close to the dreaded $4 per gallon mark (as we noted, that psychologically important barrier has already been eclipsed, in many places). AAA even predicted that Americans will travel less this Memorial Day than they did last year, the first such decline since 2002. A Deloitte & Touche LLP survey projected that 23% of folks have changed their plans because of the rising prices, with 12% of respondents canceling their vacations altogether. While some analysts targeted Memorial Day as the date for gas prices to peak, others are now looking at 4th of July, Labor Day, and beyond.

In reality, the jury is still out for the energy sector. In one group, analysts say that crude prices (which actually punched through the $135 a barrel level this week) still have a ways to go. They claim that supply will not keep up with the summer demand and point to the recent inventory levels, which have unexpectedly fallen of late. Demand in such developing nations as China continues to rise, and the devastating earthquake has only made matters worse. Additionally, some believe that the International Energy Agency is preparing a very pessimistic report on global supply/demand issues as it conducts a thorough review of the world’s largest oil fields.

On the other hand, another group of analysts believe the declining dollar and sheer speculative pressures have more to do with escalating crude prices than do actual supply concerns. They scoff at any real rationale for prices rising $4 in one day, $9 in one week, and $16 in one month. But while some feel that the elevated prices are not economically justifiable, they cannot predict with any accuracy when this "speculative mania" will end.

According to one, "it’s a fool’s errand to try and figure out when it’s going to be over. [After all], Internet stocks took a year and a half to explode."

Some oil-industry executives even believe that the politicians are to blame and are pushing for Congress to lift the "tree-hugger" ban on domestic drilling in certain environmental regions - instead of begging "friends" in Saudi Arabia to increase production. Of course, that’s more than a bit self-serving on the part of the oil companies.

Retailers highlighted the corporate news last week. Home Depot Inc. (HD) reported a 66% decline in income, while Target Corp. (TGT) announced weaker sales, as well. On the other hand, BJ’s Wholesale Club Inc. (BJ) reaped the benefits of shoppers traveling the discount route, and surprised investors with much-higher-than-expected profits. Hewlett-Packard Co. (HPQ) recognized strong overseas sales, while U.S. automaker Ford Motor Co. (F) warned that its future looks bleak as drivers shy away from the gas-guzzling sport-utility vehicles and perennially popular Ford F-150 pickup trucks that have comprised a major slice of its business in favor of more-economical cars and hybrids that are a lesser part of its business mix. Ford’s shares skidded 4.1% Friday after the company backed off its oft-repeated objective of returning to profitability in 2009.

In a broader sense on Friday, investors clearly kept one eye on high energy prices (and the damage they are causing) and the other on the clock as they prepared for the long weekend. The pessimists ruled the day as the dreaded "I" words crept more and more into water-cooler conversations; the major indexes plummeted early and never looked back.

In fact, by shedding 145 points, or 1.2%, to close at 12,479 on Friday, the blue-chip-dominated Dow Jones Industrial Average suffered its worst two-day loss since February. Financials led the downward spiral as investors speculated that the newfound focus on inflation means the next move in rates may be higher (see below). Right now, for investors, a long holiday weekend (at home?) may be just what the doctor (or the investors’ financial advisors) ordered.

Market/Index	Previous Week (05/16/08)	Current Week (05/23/08)	YTD Change
Dow Jones Industrial	12,986.80	12,479.63	-5.92%
NASDAQ	2,528.85	2,444.67	-7.83%
S&P 500	1,425.35	1,375.93	-6.29%
Russell 2000	741.17	724.10	-5.47%
Fed Funds	2.00%	2.00%	-225 bps
10 yr Treasury (Yield)	3.85%	3.83%	-21 bps

Economically Speaking

Inflation or recession? Recession or inflation? Suddenly the growing concern about energy-pricing pressures seems to be winning out. The minutes from the last central bank policymaking meeting revealed that the last rate cut was a "close call," and also said that - despite the fact that labor remains "weak" and housing "bleak" - rate reductions may be a thing of the past. In fact, the benchmark Fed Funds rate futures market has priced in a 50-50 possibility that U.S. Federal Reserve Chairman Ben S. Bernanke & Co. may start raising rates in October (and almost certainly by January).

While the producer price index [PPI] climbed by a lower-than-expected 0.2% in April, the increase in "core" (excluding food and energy prices) wholesale inflation was actually twice as high as Wall Street had projected. Additionally, some analysts point out that the recent surge in energy prices has yet to be factored into the inflation equation, meaning that the summer inflation gauges will be quite problematic.

As the Fed minutes implied, the prospects for a near-term housing rebound are indeed growing more and more bleak [Indeed, for a related story on the dour outlook for the U.S. housing market please click here].

This week, the Office of Federal Housing Enterprise Oversight reported that home prices suffered their largest quarterly decline in 17 years, the worst showing on record. The National Association of Realtors added that existing home sales dropped by 1% in April, its eighth decline in the past nine months. (On the bright side, analysts were calling for a 1.6% decrease in sales, so the poor showing was better than expected).

Weekly Economic Calendar

Date	Release	Comments
May 19	Leading Eco. Indicators (4/08)	Slight increase in April
May 20	PPI (04/08)	Surprisingly high jump in core release
May 21	Fed Minutes	Latest rate cut was a "close call"
May 22	Initial Jobless Claims (05/17/08)	Claims for benefits fell to lowest level in a month
May 23	Existing Home Sales (04/08)	8th decline in past 9 months
The Week Ahead
May 26	Memorial Day
May 27	Consumer Confidence (05/08)
	New Home Sales (04/08)
May 28	Durable Goods Orders (04/08)
May 29	GDP (1st Qtr)
	Initial Jobless Claims (05/24/08)
May 30	Personal Income/Spending (04/08)