Friday, May 23, 2008

Oil Jump Casts Shadow On Forecasts

Just when investors thought it was safe to go back in the water, they are staring at a menacing new threat. Its name is oil. For two months, Wall Street breathed a sigh of relief that the Federal Reserve had brought the markets back from the brink of a credit disaster. Stocks rallied, helped also by resilient corporate profits and expectations that the government's fiscal stimulus checks would help keep stretched consumers in a spending mood. Despite a small respite Thursday, the surge in oil prices over the past few weeks is a terribly timed shock to the system. With the economy under significant strain, the oil price jump raises new questions about the viability of forecasts for stronger corporate profits during the second half of the year and the prospects for gains in stocks. Witness the damage done to Ford Motor Co., which said Thursday that it won't turn a profit in 2009 as planned because of higher raw-materials costs and slowing sales. The problem isn't just that oil prices are rising. It is the pace of the increase. When input costs rise gradually, it is easier for companies to pass them on to customers. When oil costs rise nearly 40% in just three months, margins and profits are going to take a hit. "There's already evidence that corporate margins are getting squeezed," say Deutsche Bank strategist Binky Chadha. Thomas Lee, stock strategist at J.P. Morgan, says that oil priced at $133 a barrel would translate into an additional $300 billion in expenses to be borne by corporations and consumers in 2008. "It's a staggering number," he says. If companies were to bear the full impact of that, Mr. Lee figures it would shave about $3 a share off earnings in the Standard & Poor's 500-stock index, which are expected at $93 a share for 2008. Companies are adjusting, but they are taking steps that will have ripple effects on the economy, such as grounding flights. Meantime, the prospects for an economic boost from more than $100 billion in stimulus checks on their way to consumers looks shakier every day. The rebates amount to an extra 1% of annual disposable income for consumers, notes UBS economist James O'Sullivan. Because it's concentrated in about a three-month period, it's the equivalent of a 4% increase to disposable income during that time period -- a potentially powerful jolt to spending. However, Mr. O'Sullivan notes that the oil price increase thus far this year acts like 1.5% tax on income, Mr. Sullivan says. "It's going to pretty much neutralize" the stimulus, he says. Consumers spend less of their income on energy than they did during the 1970s crisis, but much more than just a few years ago. Time and again they've proved adept at spending through any trouble. But with home prices continuing to fall and the job market weakening, the latest surge in oil prices could be the third leg kicked out from the stool, and a big problem for stocks in the months ahead.

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