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    Why lower energy prices could be good for stocks

    The falling cost of oil should benefit companies, giving a boost to their stocks

    Published: February 17, 2015 12:45 PM

    Everyone likes to pay less at the pump, and with energy prices recently falling and some economists predicting they will fall further and stay that way for two years, cheaper gas is something drivers should be able to enjoy for a good, long while. But the effects of lower energy prices extend far beyond the fuel tank, and that has serious and intriguing implications for a wide range of investments. From consumer discretionary stocks to emerging markets to junk bonds, the fall in energy prices will be a major market theme for the year ahead, helping to create winners and losers alike.

    First, a little background: Oil prices fell about 50 percent from June 2014 to the end of the year. Slower-than-expected growth in China, the recession in Japan, and near-recessionary conditions in much of Europe have greatly curtailed demand for energy. Additionally, energy supply abounds thanks to the emergence of fracking technology and the shale-oil revolution in the U.S.

    And to complete the triangle, the dollar is getting stronger vs. other global currencies, in large part because the U.S. economy, even with all of its troubles, is healthier and more attractive than other economies in the developed world. Oil is priced in dollars, so when the greenback rises, the price of crude falls.

    Check our Home Improvement Guide for advice on saving energy at home. And find a  reliable gas furnace.

    Ordinarily, any market is supposed to find equilibrium on its own. If prices drop, supply is supposed to follow, but that's not happening in this case. (OPEC remains committed to its production targets in order to protect market share.) By the end of 2014, prices for benchmark Brent crude were around $55 per barrel, down from more than $110 in late spring. Forecasts call for further price declines in 2015.

    Retailers could benefit

    Now this is where it gets interesting. Economists figure that this drop in oil prices to a five-year low will provide global economies with more than $1 trillion in stimulus. From corporations to consumers, everyone is essentially paying less at the pump.

    Among the biggest winners from lower energy prices will be consumers and consumer discretionary stocks. Stagnant wages and sluggish job growth had made consumers less willing to part with their discretionary income throughout the recovery. That has led to disappointing sales from Walmart (ticker: WMT) to teen retailers to dollar stores. That could change as oil prices fall.

    If you look at the largest consumer discretionary exchange-traded fund, the Consumer Discretionary Select Sector SPDR (ticker: XLY), you'll see that it lagged the broader market by a wide margin last year. A consumer stock such as Walmart could actually go from being a stock market laggard to leader thanks to lower energy prices. A large portion of Walmart's customers live a long drive from stores, so they are especially sensitive to fuel prices. Other low-price retailers, such as Dollar General (ticker: DG) or Kohl's (ticker: KSS), should also see a sales boost from lower gas prices.

    Other beneficiaries run the gamut from Kimberly-Clark (ticker: KMB) (Huggies and other diapers are made from oil derivatives) to automakers (bigger cars have higher profit margins). Airlines and package-­delivery companies will also enjoy lower costs.

    Good news for Asia?

    On the international stage, emerging markets have had a rough couple of years, with problems abounding in the BRIC countries of Brazil, Russia, India, and China. And although low energy prices are terrible news for a producer like Russia, and to a lesser extent Brazil, it's a welcome turn of events for India, which imports 85 percent of its oil. Indonesia and Thailand are big importers, too.

    That creates investment opportunities in emerging markets in Asia and should provide a tailwind to ETFs such as the SPDR S&P Emerging Asia Pacific ETF (ticker: GMF) or the iShares MSCI All Country Asia ex-Japan ETF (ticker: AAXJ).

    Falling energy prices are hardly great for every industry or asset class. Indeed, when prices recently plunged for crude some sectors and stocks were clobbered. The energy sector had an ugly year on falling oil prices, and although there might be value to be found in some big oil companies such as ExxonMobil (ticker: XOM) or Chevron (ticker: CVX), oil-services companies could be too risky right now.

    The reason for that is because there's little incentive to find new sources of oil when prices are falling, and that has been brutal for the business of deepwater drillers like Noble (ticker: NE) and Transocean (ticker: RIG). Too many of their rigs are sitting idle or earning poor day rates. Other services companies, such as Halliburton (ticker: HAL) and Schlumberger (ticker: SLB), look like bad bets for the foreseeable future.

    Interestingly, the effect of lower oil prices even hurts prices for high-yield bonds because much of the market is composed of issues from energy companies.

    On balance, however, lower energy prices are a good thing for consumer, and the great bulk of corporate earnings and stronger profit growth is always good for stocks. 

    Editor's Note:

    This article also appeared in the March 2015 issue of Consumer Reports Money Adviser



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