US Economy, Commodities

Get Your Kicks on Route 66

By, 07/30/2008

Story highlights:

  • Oil and gas prices are off from record highs.
  • Some folks worry this will hurt the Energy sector, but in our view, this recent modest drop isn't enough to generate material downside surprise in earnings for most Energy companies.
  • Most importantly, lower prices don't mean the global economy is tanking (remember oil is still 60% higher today than a year ago), and falling oil prices still tell us nothing about stock price movements.

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Ah, summer: The season of that time-honored American tradition, the road trip—drop the top and get your kicks on route 66. That's how it used to be, anyway. But record-high gas and oil prices replaced road trips with "staycations" this summer. Thankfully, that might be about to change: Oil and gas are down from recent highs—something we all can celebrate on the open road!

Except not everyone's cheering. When stocks rallied recently, the Energy sector was left behind as folks feared falling oil prices would hurt the sector. Though prices are down from record highs, they're still far higher than several years ago. Plus, Energy companies were wildly profitable when the cost per barrel was $120, $100, and lower. There's no reason to believe this recent modest drop will generate material downside surprise in earnings for most Energy companies; there's still plenty of room between earnings and production costs.

But some folks worry about more than just Energy. They fear falling oil is the result of slowing demand, signaling a global economic slowdown. We suspect these are the same folks who just a month ago were shouting high energy prices would sink the economy. Both fears are inane. In order for prices to completely unwind from a global slowdown, we'd have to see the complete undoing of five years of global growth in both developed and developing regions. This would entail a recession of truly epic proportions—highly unlikely when the US has yet to see even a single quarter of negative GDP growth and the global economy continues growing at an even faster clip. What's more, energy prices have never been a reliable forecaster of stock moves or economic growth.

So what's causing prices to drop? It's impossible to say in such a short span of time. But one thing we can say: It's not because of gravity. In markets, what goes up doesn't have to come down by some magical notion of mean reversion or similar theory of equalization. The fundamentals ultimately tell the tale. On the demand side, it's possible a meaningful cycle of substitution has begun. US public transportation ridership spiked in the first quarter, with a year-over-year increase of 88 million trips according to CNN. There are also more hybrid vehicles on the roads. True, any real effect this would have in the short term is probably rather small—but small moves at the margins can mean big price changes. On the supply side, some geopolitical concerns may be easing, thanks to recently increased diplomatic relations between the US and Iran.

Bottom line: The market could be pricing in any number of things affecting future expectations. And price volatility is perfectly normal. As an investor, it's important to consider upward and downward price volatility with the same set of lenses—both are normal.

Of course, what matters most is how the day-to-day movements, as well as long-term trends, will affect stocks. But stock investors don't need to fret oil whether it's rising or falling, because oil and stocks aren't correlated. Statistical research shows oil prices explained about 1% of stock price movements since 1982. What moves the other 99% is more important—something we can all ponder between those long family sojourns from Mount Rushmore to Niagara Falls.

For more information on the energy sector, visit the Fisher Investments on Energy website.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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