A $22 rise in the price of oil could be the difference between steady gains for U.S. stocks and danger signs for the market.
Rising U.S. oil prices, more often than not, are a positive for the stock market — but not always. A Reuters survey of 20 equity strategists over the last two weeks puts $125 a barrel as the point where warnings start to flash for stocks. Currently, U.S. domestic crude oil trades at about $103 a barrel.
The $125 level is a price that would pinch consumer and corporate budgets, causing them to curtail spending sharply, and hurt key sectors of the stock market, particularly consumer, transportation and health care stocks.
"Anything in the $120-$130 range puts a dampening on the economy and destroys demand," said Natalie Trunow, chief investment officer of equities at Calvert Investment Management in Bethesda, Maryland, whose firm manages about $13 billion in assets.
Stocks have managed to shrug off the rise in oil prices and escalating tensions between Iran and the West, with the Standard & Poor's 500 index up 10 percent for the year so far.
Generally, stocks and oil rise together because both tend to benefit from a growing economy. A sharp, unexpected spike to unanticipated levels is needed for oil to take a real bite out of the equity market - similar to what happened in 2008, when oil peaked above $147 a barrel in July of that year.
Oil more than doubled in price from January 2007 to July 2008 due to a sharp increase in Chinese demand. The hit to U.S. consumer spending started to drag on economic growth before the financial crisis fully took hold in the United States.
That is why the recent relationship between stocks and oil has been a growing concern. Since the fall, the rolling 13-week correlation of returns between cash West Texas Intermediate crude oil
The relationship between cash crude oil prices and U.S. stocks has been a positive one since 1983, except for between August 2007 and July 2008, when oil prices peaked, Simons said.
"The positive relationship has started to flatten out again... we could be on the cusp, if we go higher, of going into the second negative relationship we've had since 1983," he said.
GOING WITH OR AGAINST OIL
It is interesting that there are more industries that have a substantial positive reaction to an upward move in oil than those that react negatively.
Forty industry groups in the S&P 1500 have a statistically significant negative performance beta — a measure of the volatility of an asset compared with an overall market — to crude oil prices. At the same time, 72 groups have a statistically significant positive performance, Simons' data showed, underscoring the view that rising oil prices do not usually mean a weak stock market.
But if U.S. oil hits $150 a barrel, economic growth, consumer confidence and consumption could be hit right away, and that will hurt the broader market, said Phil Orlando, senior portfolio manager at Federated Global Investment Management in New York.
Sanctions by the West targeting Iran's nuclear program have curbed oil exports from the Islamic Republic and supply could tighten further from July 1, when a ban on European insurance cover for Iranian oil takes effect.
Talks between Iran and world powers over Tehran's disputed nuclear program resume on Saturday. If the talks succeed, it could reduce the risk premium that has lifted oil prices by 15 percent this year
The fact that no one knows what's going to happen there "is a significant concern for me," Orlando said.
Consumer discretionary and consumer staples are among sectors most negatively affected by high oil prices as people alter their spending to account for fuel costs. Household product companies like Procter & Gamble
and Kimberly-Clark, soft drink makers and restaurants rank high as industries most affected.
Retailers also typically lose out when energy prices surge. In the third quarter of 2008, when oil peaked, the S&P Retail index rose 2.7 percent — and then dropped 23 percent in the fourth quarter of that year.
So far, that hasn't happened in the latest round of oil price rises. A Wal-Mart Stores Inc. executive said late last month that sales have withstood rising gas prices, and the S&P Retail index was up 19 percent in the first quarter.
Airlines and trucking companies also react directly to oil prices, and health care has a negative relationship as well, though Simons said the reason is not apparent.
BOOSTING ENERGY NAMES
Higher oil prices tend to boost energy stocks, particularly those involved in oil and gas exploration or equipment. Besides energy companies, basic materials and financials also do well with higher oil prices, Simons said, as "it tends to be a signal of greater economic strength."
Among energy companies, oil producers and oil services companies are attractive beneficiaries, said Eric Marshall, director of research at Hodges Capital Management in Dallas, Texas. Among Hodges' top holdings are National Oilwell Varco and Halliburton Co. An oil service index is up 9 percent for the year to date.
"Most of these companies don't need $100 barrel of oil to get good returns on their investment; they could do just as well at $80. But their products and services are going to be at even higher demand at $100 a barrel," Marshall said.
Despite the strength in the S&P 500, the S&P energy sector is up just 0.4 percent in 2012. That could mean it's a good time to buy the sector, analysts said.
"I'd go long the oil stocks and maybe short oil futures, if you wanted a hedge," said Nathan White, chief investment officer at Paragon Wealth Management in Provo, Utah. "I think there's value in there not being captured by the price."
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