Learning to love hundred dollar oil?
Higher oil, at least at current levels, is unlikely to derail the economic recovery, but it is an additional headwind for a still struggling consumer. Higher oil prices will add to headline inflation, lowering real-wages, and eat into discretionary purchases.
Despite the fact that the US benchmark crude oil closed last week above the $100 threshold for the first time since late 2008, equity markets have resumed their rally after a brief pause. Meanwhile political unrest in the Middle East triggered a sharp one-day sell-off on March 1st, but stocks quickly recovered and pushed back towards the February high by March 3rd.
The overall economy is demonstrating impressive resiliency to higher oil prices – as evidenced by the recent strength in the ISM manufacturing and services surveys – but investors should not be too complacent when it comes to the consumer sector. Even though labor markets are staging a slow-motion recovery, the US consumer still faces multiple headwinds, including anemic wage growth, too much debt, and a still fragile housing market. Oil crossing the $100 threshold will not help.
Some of these concerns have recently been reflected in the performance of those stocks most sensitive to consumer spending: retailers. While investors remain sanguine on the overall market, they are playing to script as it comes to the retail sector. Crude oil bottomed at $87 a barrel on February 15th. Since then prices have rallied nearly 20%. Stocks have generally withstood the spike in crude and are flat over that time period, but US retail stocks have lost roughly 2.0%. As a rule of thumb, for every 1% increase in crude, retailers have typically trailed the market by approximately 0.15%. This puts their recent underperformance right in line with the historic averages.
In recent days, we have heard the argument that the retailer sell-off is over done. The argument is that because energy represents a declining portion of consumption, the hit to retailers is not justified. From our perspective, the data does not support this argument.
It is true that over the very long term, energy-related spending as a percentage of overall consumption has dropped. However, if you focus on gasoline sales the story looks very different. Today the percentage of overall consumption currently going to gasoline is close to its 2008 peak. As of late January, spending at gas stations represented more than 10% of overall retail sales, well above the long-term average of 8.2% and the highest percentage since October 2008 (see chart below). Unless you attribute the recent rise in spending to a lot of people loading up on snacks, this months spike in oil prices should drive the ratio back towards the 2008 high. More importantly, to the extent individuals are spending more on gasoline, they are likely to spend less on discretionary purchases. If oil prices remain high, look for retailers to come under additional pressure.
US Retail Sales at Gas Stations vs. Overall Retail Sales
Source: Bloomberg, U.S. Census Bureau 1/31/11
Conclusion
Our overall investment thesis centered on a recovering global economy remains intact. That said, higher oil prices and growing political tension in the Middle East do have implications. At the very least recent events raise the likelihood of a slow down in the market’s recent gains, a pickup in headline inflation, and a more cautious US consumer. Investors should continue to overweight developed markets, US mega-caps, energy stocks, corporate bonds, and industrial commodities.
Source: Bloomberg
Certain sectors and markets perform exceptionally well based on current market conditions. Achieving such exceptional returns involves the risk of volatility and investors should not expect that such results will be repeated.
Carefully consider the iShares Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses, which may be obtained by calling 1-800-iShares (1-800-474-2737), or by clicking the Prospectuses link. Read the prospectus carefully before investing.
Investing involves risk, including possible loss of principal.
The iShares Funds (“Funds”) are distributed by SEI Investments Distribution Co. (“SEI”). BlackRock Fund Advisors (“BFA”) serves as the investment advisor to the Funds. The iShares Blog contributors are affiliated with BlackRock Fund Distribution Company (“BFDC”), which assists in the marketing of the Funds. BFA and BFDC are affiliates of BlackRock Institutional Trust Company, N.A. (“BlackRock”), none of which is affiliated with SEI.
The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications or other transactions costs, which may significantly affect the economic consequences of a given strategy.
The information provided is not intended to be tax advice. Investors should be urged to consult their tax professionals or financial advisors for more information regarding their specific tax situations.
Neither BlackRock Institutional Trust Company, N.A., and its affiliates nor SEI and its affiliates provide tax advice. Please note that (i) any discussion of U.S. tax matters contained in this communication cannot be used by you for the purpose of avoiding tax penalties; (ii) this communication was written to support the promotion or marketing of the matters addressed herein; and (iii) you should seek advice based on your particular circumstances from an independent tax advisor.
This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any security in particular.