Investors (and hence the markets) were surprised by two economic developments over the past few weeks, surprises that were more a matter of degree than of something totally out of the blue. The first, of course, was the precipitous decline in the price of oil, which now trades below $60 per barrel; the second was the robust employment report, which showed that the economy added some 321,000 jobs in November, significantly above expectations. We'll take a look here at the implications that these two developments might have for some stocks.
The lower oil prices appear to be the result of excess supply relative to demand. New technologies for getting oil out of the ground, the hydraulic fracturing process known as "fracking," have resulted in a greater supply of oil. At the same time, economies around the world are weak, even as our economy here in the U.S. is picking up a head of steam, resulting in subdued global demand for oil. Combine that with OPEC's decision not to cut back production, and what you get is a textbook case of supply/demand imbalance that takes prices lower.
The price of a barrel of oil stood at around $100 in the middle of this past summer and started falling from that level in September and October before the plunge in December to below $60 per barrel. Most of us experience the economics of oil at the gas pump, where economists say that our demand for gasoline is inelastic (not flexible or not responsive) with respect to price, at least in the short run. This just means that we can't immediately reduce the amount of gasoline we buy when the price increases--so it costs us more to fill up our tank. In the longer run we might buy a more fuel efficient car or ride a bicycle, but such adjustments are likely to take some time. The result is that, with our driving patterns fixed, we end up spending more of our money on gasoline. Now when the price of gas falls, we don't buy more of it so we can drive extra miles every week. We end up spending less of our money on gas, with more money to spend on other goods and services. That's why economists say that a decline in gas prices acts like a tax cut in the economy. If the price of steak were to decline relative to the price of, say, chicken, then we might eat steak more often--demand for steak is relatively price elastic. If the price decline were compelling enough, we might buy some additional steaks to store in the freezer. We can't do that with gasoline, unless we want to run the risk of burning the house down.
The price of oil matters far beyond the gas pump, because oil is embedded in just about everything, from my grandson's car seat to my wife's nail polish, not to mention the energy it takes to run the factories and the fuel consumed by the planes, trains, and automobiles that move all this stuff from the manufacturing plants to the store shelves. Cheaper oil means lower costs to a multitude of businesses, and that means higher profit margins. At the same time, the economy continues to improve, most notably with a long-awaited acceleration in the jobs picture--more jobs mean more spending power. That could make for something of a "sweet spot" for Memphis-based FedEx (FDX, $176): greater economic activity, continued growth in online commerce, and cheaper fuel. The stock stumbled a bit earlier in December after reporting earnings that were shy of expectations, but if these trends hold, the future might offer surprises of the positive variety from FDX.
Ready to Roll?
With more traffic on the highway of commerce, the toll booth operators should fare well, also. That would be VISA (V, $267) and Mastercard (MA, $88), who stand to benefit from the greater number of transactions that come with an improved economy. In addition, some huge percentage of the world's transactions are still paid for with cash, and with greater adoption of electronic payments, V and MA benefit from a secular, long-term trend as well as from the cyclical economic recovery. To play out this thesis further (and it is just a thesis, remember), I'll note that Argus Research recently raised the Consumer Discretionary sector to Over-Weight from Market-Weight. That sector includes a host of different sub-sectors and companies: autos, apparel, hotels and leisure, appliances, etc. It's the stuff that you don't have to buy (Consumer Staples, such as food) but typically do buy when you feel better about your economic situation. We didn't have to buy our grandson a personalized gingerbread train for Christmas, but we did, and it came from Williams-Sonoma (WSM, $76)--without ever setting foot in the store. WSM stands out as one of the few traditional retailers to have mastered online commerce. They also stand to benefit from a continuing improvement in housing, because you can't very well set up housekeeping without corkscrews, knives, and spatulas.
One glaring disappointment of this economic recovery has been the lack of wage growth, but that may be changing. In fact, the Consumer Discretionary thesis depends on it, because something more than cheaper gasoline has got to power it. That something, of course, is higher personal income numbers that are the result of more jobs and better wages. I find it interesting that we're not hearing a lot more about this from the Wall Street gurus, many of whom were, just weeks ago, still pounding the table for energy stocks.That makes the Consumer Discretionary thesis a bit of a Contrarian play, but that's usually how to make money in stocks.
NEXT: A look ahead to 2015.
Life is short. Get busy. And Merry Christmas!
Jim
Please post any questions or comments to the "Comments" section, and I will address those in a future post.
Please post any questions or comments to the "Comments" section, and I will address those in a future post.
Disclosure/Disclaimer:My family members and/or I own shares of FDX, V, MA, and WSM. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here shoul be construed as the advice to buy or sell any security.
