The Dilemma of Cheap Oil

What’s been good news for Main Street has added increased volatility to Wall Street as lower oil has proved to be quite
the dilemma. WTI (West Texas Intermediate) Crude has experienced a free fall since mid-Summer moving from over $100 per barrel to under $50. Gas prices have followed suit giving the American household a boost to their bottom line. Nevertheless, the energy sector is a key factor in the US economy and equity markets worldwide have been spooked by the lower price of oil. As oil has dropped, many companies in the sector have seen their profitability plummet. Some think the lower demand for oil speaks to a larger issue of slowing economic growth. This has caused many shareholders and investors to move out of stocks and into the safety of bonds. 

Using a longer term outlook, we feel this paradox of low oil prices will prove to be a temporary market trend. There are
a few reasons for this:

  • Many companies and sectors will benefit from lower oil costs. Everything from auto sales and airline profits, to shipping and consumer spending will be positively impacted. 
  • The US economy has continued to add jobs seeing the unemployment rate fall to 5.6%. 
  • The value of the Dollar has continued to strengthen; attracting capital from around the globe. This has also helped hold down inflation while increasing purchasing power for consumers and businesses. 
  • The combined effect of lower energy costs with a strong dollar is exactly the supply-side growth mix that sparked booms in the 1960’s, 80’s and 90’s. 

As we look forward to 2015 we are focused on a trend that saw US stocks fare better than their international counterparts last year. In 2014 US equities (Russell 3000 Index) increased by 12.36% while international stocks (MSCI EAFE Index) decreased by 6.20%. While international stocks (particularly those in Europe and Japan) suffered modest losses in 2014, we still feel that they are an important part of our asset allocation models moving forward. Valuations of these equites are a depressed compared to the US and bullish influences such as monetary stimulus in Europe look to be a likelihood this year. While US equities still look attractive, given the relative strength of the US economy, the potential economic stimulus in Europe and low valuations of international stocks suggests a balanced level of region exposure is still most appropriate. 

As always, we encourage any thoughts, questions, or concerns you may have. We look forward to talking again soon and wish you a safe and Happy New Year.