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
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.
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