Why haven't oil prices hurt the stock market?

Oct. 29, 2004 — Q: I don't understand why the stock market hasn't taken a dive over the past few weeks accompanying the higher oil prices. I thought one correlated with the other. I haven't seen the impact at the gas pump (yet) but I expected to see an immediate reaction in the stock market. Any ideas? —Caron O., Langley, Wash.

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A: This is another example where the “averages” tend to hide what’s really going on. (As Answer Desk readers are quick to remind us whenever we cite the latest nationwide gasoline prices, those national numbers often have little to do with what you’re paying at the pump in your neighborhood.)

In this case, stocks — overall — haven’t been hit as hard as you might expect from the run-up in oil prices, which has pushed the spot price of a barrel of crude from about $30 this time last year to the mid-$50s this week. The last time we saw a surge like that was on the eve of the Gulf War in late 1990, when oil prices doubled in less than 3 months and a barrel of crude hit $41. A the time, the stock market beat a hasty retreat. But the oil spike was short-lived, and the market quickly recovered.

This oil price rise looks different. For one thing, worries about supplies aren’t tied to a single event like the Gulf War. OPEC countries are pumping as fast as they can and can barely keep up with global demand. Russia’s oil industry is in limbo as the government battles one of its biggest producers. More recently, hurricanes in the Gulf of Mexico halted crude shipments and put a dent in inventories. Despite all this, demand for oil keeps rising at a healthy pace.

Ordinarily, this should have the stock market pretty spooked. But some investors apparently suspect this oil price spike may also be short-lived — and that futures traders may have overestimated the threat to supplies.

Even if they're wrong — and oil prices keep rising — higher energy prices haven’t stopped overall corporate profits from rising, as many companies continue to report better earnings for the latest quarter. There several reasons for this. First, much of the oil now being consumed by American businesses was bought under fixed-contracts that were negotiated a while ago — at less than $50 a barrel. Second, the U.S. economy overall is less dependent on oil than it was even a decade ago. (Each dollar of U.S. GDP produced today takes about half the oil it did 30 years ago.) And the real price of oil — adjusted for inflation — is still less than it was during the “oil shocks” of the 1970s, when higher oil prices did send both the stock market and the U.S. economy reeling.

That’s not to say higher oil prices haven’t had a major impact on stock prices — depending on which stocks you’re looking at. Airline stocks, for example, have gotten hammered, falling more than 40 percent since March.  Energy stocks, on the other hand, have seen a huge windfall from the run-up in oil and natural gas prices; those stocks are up 34 percent in the past 12 months.

So, for the time being, Wall St. seems to be paying closer attention to rising profits than to rising oil prices. And even though the U.S. economy is still relatively sluggish, some industries are doing much better than others. Computer companies are in the second year of a healthy rebound. And health care profits just keep chugging along — on track to post a 22 percent profits gain this year, according to S&P's earnings estimates.

What happens next? Sorry, the Answer Desk crystal ball is in the shop again. It started smoking again last week after a flood of e-mail about The Great Gasoline Price Conspiracy. (See last week's entry.)

A lot depends on whether oil prices keep rising from here. The Federal Reserve’s latest report card this week said the U.S. economy is still growing overall. But it’s weakening in some parts of the country as higher energy prices begin to squeeze spending by businesses and consumers. If that keeps up, it’s hard to see how the economy — and corporate profits — can continue to expand.