Well, the year has gotten off to a bumpy start with oil prices taking over the headlines.
Last Monday’s 331-point drop in the Dow Jones Industrial Average was attributed to oil greasing the skids. Oil’s price dropped below $50 per barrel at one point on that day, but then it actually fell further and closed below $50 at $47.93 on Tuesday as the Dow fell another 130 points.
Last Wednesday, oil remained under $50 at $48.77, yet the market had a huge up day, rising 213 points. Then on Thursday, stock went up another 1.8% or so. But what’s all the concern surrounding oil, and why are markets apparently moving to the oil beat?
Let’s consider the pros and cons of low oil prices:
An obvious negative is that lower oil prices mean lower profits for oil companies and exploration and production (or E&P) companies. As we saw in December, this can translate into stress for certain parts of the market beyond stocks, such as in the high-yield bond arena, where energy companies (not the global giants, mind you) make up 15% to 20% of the market.
Additionally, lower oil prices reflect slowing in two huge global economies, China and Europe, which means that demand may be falling broadly in those economies. If demand continues to contract, whether for oil or for other goods and services, then the world’s in trouble.
On the positive side of the ledger, lower oil prices could mean higher profits for a host of companies: Airlines, automakers and chemical companies are obvious winners. But retailers also win, as lower prices at the pump mean more money in consumers’ pockets. This applies to foreign consumers as well, particularly in Europe. So, those slowing economies may actually find a silver lining in oil’s decline.
Finally, lower oil prices means the U.S. balance of trade shifts. With our trade deficit narrowing, it’s possible that fourth-quarter GDP growth will be stronger than many economists anticipate.
As I said, our economy is doing fine. Final numbers show that auto sales increased 9% over the past year and reached 16.5 million units, up from 15.6 million in 2013 — the best pace since 2006. And while hiring remains strong, manufacturing and service sector gauges, while still well in expansion mode, weakened a bit at year-end.
Senior Editor Dan Wiener and Editor/Research Director Jeffrey DeMaso publish The Independent Adviser for Vanguard Investors, a monthly newsletter that keeps abreast of recent developments at Vanguard, and the annual FFSA Independent Guide to the Vanguard Funds.
