A January 9th report from Goldman Sachs Portfolio Strategy Research argues that while increased consumer spending due to lower oil prices alone will not compensate for the overall drag on earnings from the energy sector, when you add in reduced production costs you will see an overall boost to major index earnings.
In the introduction to their report, GS analysts David J. Kostin and colleagues explain their point of view. “The diffuse major positive earnings boost from lower oil will occur through higher profit margins. BEA data show that energy input costs equate to more than 2% of US private industry gross output (revenues). A 40% year/year decline in oil prices implied by futures should reduce costs and lift margins by more than enough to offset the EPS drag from reduced Energy earnings.”
Lower oil prices will boost S&P 500 profit margins
Kostin et al note that each 50 basis point move in S&P 500 profit margins equals roughly $5 in S&P 500 earnings per share. Moreover, U.S. Bureau of Economic Analysis data highlight that energy input costs equate to more than 2% of US private industry gross revenues. Therefore, a 40% drop in oil prices should lower costs and expand margins by more than enough to offset the net earnings headwinds from the beaten-up energy sector. The relative benefits of lower oil prices vary substantially by industry, with transportation seeing the most benefit and information technology the least.
Lower oil prices will hit S&P 500 capex spending
Capex spending is already taking a major hot due to low crude prices, and analysts say there’s a lot more to come. Of note, energy sector capital expenditures account for a third of total S&P 500 capex.
The report also highlighted a survey at the Goldman Sachs Energy Conference last week where 77% of investors anticipated onshore E&P capex to decline by 20%-35% in 2015. Kostin and colleagues argue “…that the recent underperformance of Industrials is largely due to these expectations, and we continue to recommend clients underweight the sector.”
Goldman Sachs projects 3.4% US growth for 2015
Also of interest, recent ISM surveys offered relatively weak data. December payrolls beat expectations and unemployment fell to 5.6%, but tepid hourly earnings and household employment growth provided offsetting disappointments. Even though the US economy grew by close to 4.5% in November and December, the GS team projects growth will start to slow down toward their full-year 2015 estimate of 3.4%.