January 8, 2020

Oil price spike clouds corporate profit outlook, putting investors on edge

NEW YORK (Reuters) – The spike in oil prices due to the escalating conflict between the United States and Iran is causing investors to worry that U.S. corporate earnings will be crimped by rising energy costs.

While the energy sector would benefit from higher oil prices, other sectors ranging from shipping to manufacturing to restaurants would see their profit margins compress as gasoline prices rise. Some investors said they were acting more defensively against this backdrop.

“Oil is still not prohibitively expensive, but it’s significantly more expensive than it was when companies were making their budgets a year ago,” said John LaForge, head of real asset strategy for Wells Fargo Investment Institute. “They might have the ability to pass it on or they might not, but overall there is going to be a hit to margins.”

Though at $70 a barrel the price of oil remains far below the level that would send the United States into an immediate recession, higher energy costs at a time of increasing geopolitical risks are likely to leave investors and companies skittish, fund managers and analysts said.

Over the last year, the price of oil has jumped nearly 25% according to Refinitiv data, raising costs for companies across the economy and leaving less money in the pockets of consumers.

The conflict between the United States and Iran escalated early Wednesday with an Iranian missile attack on U.S-led forces in Iraq, sending S&P 500 futures down more than 1.5%, before retracing. They were last down 0.2%. The benchmark S&P 500 closed Tuesday down 0.28% and is up a modest 0.2% a week into the new year after jumping nearly 30% in 2019.

First-quarter earnings of companies in the S&P 500 are expected to rise 6.2% over the same quarter in 2019, according to estimates from Refinitiv that were made before the jump in oil prices. Those estimates are largely based on assumptions that economic growth will rebound in 2020, though corporate earnings are expected to have fallen by 0.6% in the fourth quarter of 2019; companies will begin announcing their results next week.

The likelihood that oil stays at current levels or moves higher will push more investors into a defensive crouch until it becomes clearer how companies are responding, said Barry James, a portfolio manager at James Investment Research.

“Stocks are not cheap and we’ve had this huge run-up and sentiment had gotten dangerously bullish,” he said. “I would want to have at least a moderate position in energy if I didn’t have any and some gold in my portfolio.”

The attacks should serve as a wake-up call to investors who piled into stocks during the S&P 500’s months-long rally, said Christopher Stanton, chief investment officer at San Diego-based Sunrise Capital LLC.

“We’ve had three months of asymmetric upward moves in the equity markets,” he said. “Things have become increasingly overbought. If you’re an investor, don’t you want to take it easy here and back off a bit?”

Still, oversupply in the global oil market and the emergence of the United States as the world’s top oil producer will likely keep oil below $75 a barrel as long as the conflict between the United States and Iran does not escalate to the point where Iran attempts to close the Strait of Hormuz, a chokepoint through which about a fifth of the world’s oil supply flows, LaForge said, as he put the price of oil in perspective.

“This is still a small move historically speaking,” he said.

Source: reuters.com

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