Tuesday, January 6, 2015

Why Oil Is Dragging Down the S&P

Why Oil Is Dragging Down the S&P

Why does falling oil, a boon to consumers, keep knocking down the Standard & Poor’s 500 Index? To Bank of America Corp., it’s because of the possibility companies will cancel plans for capital spending.
Earnings in the benchmark gauge for American equities may be as much as $6 a share lower than analysts forecast this year should oil stay below $50 a barrel, according to Savita Subramanian and Dan Suzuki, New York-based strategists at Bank of America. The S&P 500 (SPX) has declined 4.2 percent since Dec. 29, sliding for five straight days as West Texas Intermediate crude fell below $49 a barrel for the first time since 2009.
While the 55 percent retreat in oil since June is good for stores and restaurants, it’s a mistake to overestimate the importance of those industries to the S&P 500, Suzuki said. Equities take a bigger cue from business spending, and because so much of that is tied to commodities the net effect of lower oil on earnings over the next few months is negative.
“The direct impact to profits in the energy sector and energy-related companies in the industrials sector far outweighs the positive impact on the consumer sectors,” Suzuki said by telephone. “The positive impact for other sectors is actually pretty muted.”

Cut Projections

The tumble in crude prices has prompted energy-stock analysts to slash estimates for capital expenditure for the next year, cutting them as much as 9.1 percent since July, according to data compiled by Bloomberg. Oil-and-gas companies are expected to lower investment by 6 percent in 2015, the most in six years.
Industrial companies will also slash capital spending this year by 15 percent, the first decline since 2009, projections show. U.S. Steel Corp., the country’s second-biggest producer of the metal, said this week it will lay off more than 750 employees at two pipe plants as the oil-price slump cuts investments by energy companies.
Both JPMorgan Chase & Co. and Evercore ISI slashed ratings on industrial stocks in the last week, citing the decline in oil and natural gas prices. Caterpillar Inc. (CAT), along with Actuant Corp. and Parker-Hannifin Corp., were lowered to the equivalent of a sell by JPMorgan’s Ann Duignan. Evercore’s David Raso cut his ratings on Caterpillar, Terex Corp. and United Rentals Inc., saying the three machinery companies have the most to lose from the selloff in energy prices.

Capital Spending

Projects by companies in fields such as in fracking, drilling and rigs have ramped up in the last five to 10 years and now account for about 40 percent of all capital spending, Citigroup Inc.’s Tobias Levkovich wrote in an October note.
Bank of America’s opinion that oil’s slump will trim profits contrasts with Goldman Sachs Group Inc.’s view. The latter’s David Kostin reiterated in a Jan. 5 note that every drop of $10 a barrel lifts earnings by $2 a share.
While the price declines in energy stocks have left the group with the weakest influence on U.S. equities in nine years, overall profit growth for the S&P 500 will still be crimped this year.
Earnings at energy companies of the index will fall 22 percent in 2015, bringing down the increase for profit by the broader gauge to 6.4 percent, according to the average analyst estimate compiled by Bloomberg. When oil prices reached a high in June, earnings growth was projected to be 6 percent for energy shares and 11 percent for the S&P 500, the data show.

Profit Share

Oil-and-gas producers will make up 9 percent of S&P 500 profits this year, down from 11 percent in 2014, according to Suzuki. Consumer-discretionary companies will account for 10 percent of profit this year, with staples stocks making up 8 percent, he said.
“Capital spending slows when the oil price falls,” David Kotok, chairman and chief investment officer at Sarasota, Florida-based Cumberland Advisors Inc., said in a note yesterday. His firm oversees about $2.3 billion. “We already see that process unfolding. Energy capital expenditures will decline; the U.S. renaissance in oil will slow, and development and exploration will be curtailed.”
To contact the reporter on this story: Inyoung Hwang in London at ihwang7@bloomberg.net
To contact the editors responsible for this story: Cecile Vannucci at cvannucci1@bloomberg.netChris Nagi

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