Cheap Oil & Top Line Growth

The Conundrum of Cheap Oil and Drilling in the Sky:

Two clear trends have evolved over the last couple of years, and we were reminded of both.  

U.S. Gross Domestic Product (GDP) for the second quarter came in at 1.2%, well below the 2.6% that Wall Street expected. The big miss doesn’t tell the whole story.  Consumers are spending while businesses are not.

Personal Consumption +4.2% (Highest since 4Q 2014)

Business Investment -2.2%

• Structure -7.9%
• Equipment -3.5%

The biggest winner from consumer spending is the cloud where more and more of those transactions are taking place. We’ve seen it this earnings season.

Big cloud winners include Amazon (AMZN), Microsoft (MSFT), International Business Machines (IBM), and even Google/Alphabet (GOOG/GOOGL), which says it will be bigger than searches in 2020.

On the other hand, two big losers underscore the conundrum of cheap oil and how it is hurting the economy.

In the last three months, Exxon (XOM) spent $1.5 billion less on capital projects, a 49% decline from a year ago and 57% for second quarter 2014.  It’s the same story at Chevron (CVX) where the company spent almost one billion less than last year. 

Think of all the lost jobs from construction workers to roughnecks. It’s very hard for most folks to connect the dots of extraordinarily cheap oil/gasoline to a weak economy. The price of oil is a proxy for the health of the economy. Sure, there is the supply element; there used to be an emotional element known as geopolitical risks, but that doesn’t seem to matter anymore. 

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Make no mistake; however, crude above $51.00 will coincide with higher wages, greater job growth, and good jobs at that.

Big Investment -Not Anytime Soon

Big businesses are not going to make major investments with the mountain of rules, fees, regulations, and fines.  Who wants to kick up dust while building a factory only to be fined for it?  However, the consumer probably keeps the economy from tipping into a recession.

This week, we get the jobs report.  I think it will beat consensus; the key is wages. There is an abundance of anecdotal signs that wages are ready to move higher.  While that might create problems for the Fed, it could add more credence to the rally.

Earnings Update

• 71% companies beat on earnings (67% historic average)
• 57% companies beat on revenue (55% historic average)

That kind of meritocracy is beginning to come through this earnings season.  It’s understandable since so much money has flowed into equity ‘safe havens,’ but it was tough justifying gains in utilities and consumer staples before the earnings season; and now, it’s impossible.

Guidance

Not only have utility and consumer staples come up short thus far this earnings season, but guidance also has been a major disappointment with none of the names that have already posted results, offering upbeat guidance for this quarter.

Overall, corporate America continues to struggle, but top line growth has come in higher year-over-year for the first time since the fourth quarter of 2014. 

Inflection Point

The big question is whether this might be an inflection point.  It’s too soon to know, although I am impressed with big names that have destroyed earnings consensus with stronger-than-expected revenues. This market needs better news from corporate America to get this market higher…so far, it’s getting it (so far).