Interactive Investor

Oil's benign decline

6th February 2015 09:50

by Ken Fisher from ii contributor

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Last decade, everyone feared high oil prices would drain folks' wallets, bleed businesses and capsize global GDP. Today, oil is down over 50% since June. Brent crude closed January at $48.40/barrel. So why the heck aren't people partying?

Oh, some cheer. BoE Governor Mark Carney calls cheap oil a consumer tax cut. Headlines hype its retail sales boosting magic. But most see danger. Oil markets signaling a huge recession stocks haven't priced in yet. Or the death of North Sea oil. Or OPEC using oil as a weapon. Don't believe it! These are all false fears, signs sentiment is too darned dour.

Oil is a commodity - not magic, not a leading indicator. Never has been! Prices move on supply and demand, with occasional sentiment-driven swings. Just like iron ore, copper, tungsten and pork bellies or any other boring commodity. Would people freak if pork bellies plunged? No way - they'd celebrate cheap bacon! Oil isn't different. (Just don't eat it.)

Crude's decline is simple: Supply grew faster than demand. Benign! Boring! Oil markets could signal economic disaster only if they knew something stocksmarkets didn’t. Impossible! Information moves too freely and fast. Stocks discount the mid-term future. Commodities never have. It is impossible to think stockmarkets don't already fully reflect current oil prices always. Who doesn't know about them? No one.

Don't overthink it

Those warning oil's volatility is contagious miss this: Stocks already discounted oil's swings! Energy stocks got hammered! Cheap crude chops oil producers' revenues. They've lagged for years - markets started pricing rising oil supply eons ago. Broader stockmarkets rightly yawned. They know cheap oil just creates winners and losers. Energy firms lose. Consumer discretionary firms win since folks have more disposable cash. Manufacturers get a lift from low energy costs. All priced in. Don't overthink it.

Don't overthink North Sea oil either. Cheap oil does hurt drillers. But this shouldn't whack your economy. For North Sea production to dive, prices would have to stay low for ages. Offshore oil exploration takes significant time and investment to reap returns. Firms pumping off Scotland today already sank huge costs into it. Why slash output and get zero return on that upfront investment, when by pumping you at least earn something? Savvy businesses think long-term.

Competition is a war!

If prices stay low, firms may cancel less profitable exploration and drilling. Happened in America in the 1980s and 1990s! But oil extraction is about 1% of total UK output and has declined for years. Yet the economy grew! Last year's real oil output was the lowest in decades. Real GDP grew the fastest since 2007 and hit a new high. The North Sea won't make or break Britain.

And those fears OPEC is "weaponising" oil, depressing prices to hit non-OPEC production? When businesses do that to take market share it's "competition," and regularly benefits consumers. There is no competition-quashing monopoly here. Not today! Today competition is a war! Pundits wish OPEC would surrender and cut output! Huh? Stupid! Contrast that with the past 40 years, when "peak oil" fears reigned and everyone dreaded falling supply. Sentiment here is upside down.

Stocks to own

I'm not arguing low oil is massive stimulus - again, winners and losers. But headlines are too drearily brain dead. Oil's slide isn't bearish for Britain or the world. People just think it is - bullish! Another fat false fear, another brick in the wall of worry for stocks to climb. Climb it with stocks like these:

GlaxoSmithKline has been doggy, drowned in nose-diving sales of its asthma drug, Advair. Buy! Analysts are overwhelmingly negative - it's likely today's most hated big pharma stock, which means I love it. Sales of new respiratory drugs Breo and Anoro should compensate for Advair, growing faster than expected. Its 6.1% dividend yield lets you be patient sentiment improves.

Multiyear history, Greek nonsense and recession fears cause pessimism for Italy. You run through the world's 158 largest stocks to find Italy's first - global energy giant Eni, which isn't terribly Italy-sensitive. Amazingly, only 11 of the 1,200 largest stocks are Italian - mostly way down that list. That alone is enough to own some of the world's eighth-largest economy. Try its top insurer, Assicurazioni General (G), 41st globally in revenue but only 354th by stock size.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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