How Rising Oil Prices and War in Europe Could Impact the Stock Market
(Please enjoy this updated version of my weekly commentary published March 4th, 2022 from the POWR Stocks Under $10 newsletter).
Over this past week, the S&P 500 is about 2% higher. It seems to continue to drift higher off the momentum generated by last Thursday’s powerful reversal.
And, I have to say that the market has been quite resilient in the face of a torrent of negative news/headlines such as the Russia-Ukraine invasion, rising oil prices, inflation, Fed hikes, etc.
Now, let’s dig into some topics…
As we’ve frequently discussed, I’m equally interested in the market or a stock’s reaction to news as I am in the actual news, because this gives some insight into whether we are in more of an accumulation or distribution phase.
Doesn’t help in terms of market direction but gives us some clues about the potential move in either direction. So, in terms of the market right now, I think it’s in a place where any movement towards a resolution or tamping down of the war or good economic data or even the absence of bad news has the potential to send the market soaring higher at a blistering pace.
On the other hand, the capacity to absorb bad news and selling has been impressive, but there’s a limit to it. So if it does continue, the dam could break and we could revisit lower prices.
Energy has been the star performer. I’ve been bullish on energy for nearly 2 years. But even I’m surprised by the intensity of gains and how quickly we are back above $100/barrel.
Even absent this Russia issue, I believe the world was in big trouble due to underinvestment in energy over the last decade.
What’s incredible is that even with oil prices above $100/barrel, companies are not materially increasing production or investing significant sums in E&P.
Instead, they are paying off debt and returning cash to shareholders. This makes investors happy, but I think the bull market doesn’t end until we get more investment in new production.
On the demand side, the pandemic led to much less demand destruction than expected while there was significant supply destruction. (Oil prices were weak even prior to the coronavirus.) And, demand should exceed pre-pandemic levels in 2022.
Demand is interesting, because in the very long-term it’s going to be much lower as efficiencies keep increasing and compounding, and alternative energy keeps taking a larger share of energy production. But, we are decades if not a century or two from this happening.
Instead, the modest decline in demand from efficiencies is dwarfed by the increase in demand due to more economic activity and the thousands of people who enter the global middle class on a daily basis and start living a more first-world type life in terms of transportation and amenities.
Things we may take for granted like refrigerators, air conditioning, cars, tech devices, etc. And obviously, all of these things take energy to make and operate.
Given this backdrop in energy, the Ukraine-Russia news is like throwing a match in a tinderbox.
It also has ramifications for inflation as so much of it is connected to energy. But, then I look at other inflation components that are less connected to energy like rents, wages, healthcare, and house prices. And, these are also trending in the wrong direction.
We do have a major deflationary pulse coming with the normalizations of supply chain issue and transportation bottlenecks easing. I’m confident that this will happen, because it’s simply a matter of companies responding to incentives.
But, why hasn’t it already happened?
Well, whenever things have started to improve we have been hit hard by another outbreak. Compounding this was the zero-COVID policy of many Asian countries. Adding to this was the pandemic and stimulus leading to an increase in the demand for goods as spending for travel, services and other categories dropped.
Maybe the best stat that sums up just how wonky everything is: “The spot rate for a 40-foot container between China and the U.S. West Coast was $15,898 including surcharges and premiums as of Feb. 27, about nine times higher than the cost in February 2019” – Freightos
Now, we are on the other side of the pandemic. (yes, kind of a bold call). So, I think we are going to see the other side of the coin with goods demand dropping, and companies being able to work through their backlogs and supply chain issues.
But, while at one point, I thought this deflationary pulse could bring inflation back down to its normal range thus giving the Fed more room to maneuver. This is no longer the case as inflation is increasingly entrenched in multiple parts of the economy.
With Q4 earnings season about done, it’s clear that earnings growth (the #1 factor when it comes to stock market performance) remains bullish. 76% of companies beat expectations, and the earnings growth rate for Q4 was 30.7%.
Going into earnings season, analysts were expecting a 20.1% increase. So this is a major bullish tailwind for the market.
The market’s forward P/E is now 18.8 compared to a 5-year average of 18.6 and a 10 year average of 16.6. For Q1, analysts are expecting 4.4% earnings growth.
It’s clear that the earnings trend remains strong and supportive of this bull market. That being said, we do have 2 bearish forces: inflation and the uncertainty around the Russia-Ukraine crisis (basically the risk that it becomes a larger confrontation that draws in more actors.)
Given this, we can expect that a choppy market environment is the norm.
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All the Best!
Chief Growth Strategist, StockNews
Editor, POWR Stocks Under $10 Newsletter
SPY shares . Year-to-date, SPY has declined -9.01%, versus a % rise in the benchmark S&P 500 index during the same period.
About the Author: Jaimini Desai
Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of the POWR Growth and POWR Stocks Under $10 newsletters. Learn more about Jaimini’s background, along with links to his most recent articles. More…