How Can We Benefit from Lower Oil?

The price of oil has been falling since the summer of 2014, but for a brief rally in the first quarter of 2015. This last dramatic leg down, beginning in May, is considered one of the catalysts for the current stock market correction. In fact, one aberration of this fall, the change in the price of oil has temporarily become a gauge of global economic strength – and a primary indicator of day to day stock market performance.

Yet, the sharp decline in oil does not correspond to an equivalent weakening of the U.S. or global economy. Rather, ex the energy sector, the broader economy should benefit. The collapse in oil prices is as good as a tax cut for the consumer, a profit increase to producers and manufacturers, and an overall stimulus to the economy. More importantly, low energy and input prices typically herald a period of expansion, not recession – as is currently feared.

As a personal testimonial, my wife and I recently reviewed our home heating fuel bill. At this time last year, we were paying $2.81 per gallon. Today it could be delivered to our house for $1.43. With an annual consumption of 1,050 gallons, we should expect an annual savings of up to $1,500 – or $120 per month. If we also adjust our budget for lower prices at the local gas station it’s easy to see how we are all getting a meaningful enhancement to our discretionary income and purchasing power.

The question is, as investors what investment opportunities exist as a result of the precipitous decline in energy prices? Three investment themes come to mind:

Consumer discretionary stocks

The energy “tax cut” (heating fuel and gasoline) will indeed improve household discretionary spending. Coupled with the improvement in housing starts and existing home sales, we should expect to see higher retail sales in a broad array of categories. Stocks in industries such as home improvement & supplies, specialty retail, and consumer electronics should benefit. The Consumer Discretionary Select Sector SPDR ETF represents a basket of stocks in this sector and is an easy way to invest in this theme.

Industrial Stocks

For many industrial producers, oil is a major input cost – and lower oil prices reduces the cost of production. Yet, while oil prices have declined the economy has remained strong enough for producers to maintain, or slightly increase, the prices of their finished goods. The result is higher profits margins. The same dynamic is true for airlines and bulk shippers. Stocks in industries such as industrial paints & adhesives and transportation should benefit. The iShares U.S. Industrials ETF represents and basket of stocks in this sector and is an easy way to invest in this theme.

Energy Stocks

The most direct way to benefit from a steep and rapid decline in energy prices is to invest in the energy stocks themselves. Favorable investment points are being created by the current glut of global oil supply. Quality Large Cap integrated oils and refining companies will survive this period and live to thrive another day. Other babies currently being thrown out with the bath water are select MLPs focused on pipelines and storage. These companies are essentially the toll roads of the energy highway – once out of the ground, oil and gas needs to be transported regardless of the price of West Texas Intermediate.

The current global stock market environment, fed watching, and oil supply demand uncertainty are converging to create investable opportunities. There will be a future and energy will be part of it.