THE steep dive in crude oil prices in recent months has left Wall Street struggling to clarify what impact it will have on overall US corporate profits.

S&P 500 earnings are still expected to have risen over the past quarter, as economic activity in the US improved and job creation averaged nearly 250,000 per month in 2014. But the outlook for oil prices overshadows an equity market whose bull run in recent years has been distinguished by a lack of appreciable corrections in the past three years.

Among Wall Street strategists there are notable differences of opinion as to how falling oil prices will influence the overall market. Strategists with Goldman Sachs say S&P 500 earnings could rise $2 for each $10 drop in the price of a barrel of oil in 2015. However, those with UBS estimate every $10 increase in the barrel of oil will lift S&P 500 earnings by roughly $1 per share.

“Should energy sector forecasts get trimmed further without any upward revisions elsewhere, it is fair to consider the need to reduce aggregate growth expectations,” says Tobias Levkovich, a strategist with Citi.

Profit forecasts for the S&P 500 have been clipped in the weeks leading up to fourth-quarter earnings season, which kicked off with results from Alcoa on last Monday, as analysts have cut their expectations for the energy sector.

Offsetting the energy industry gloom is an estimated $150bn effective tax cut from lower gasoline prices, which has reduced input costs for industrial producers. Along with powering up consumer spending, the overall boost for the economy is proving difficult to calculate. Howard Silverblatt, senior index analyst with S&P Dow Jones Indices, says: “We have guesses, educated guesses, substantiated guesses. But you don’t know where oil is going to stabilise [and] you don’t know how the energy issues will do, including on their profitability and expenditures.”

‘We had a once-in-a-generation move in energy and the market needs some time to digest what it means for the economic picture and for earnings. And that’s not done yet’

S&P 500 fourth-quarter earnings forecasts have fallen steadily since July 1, when Brent crude prices had only just begun to slip from more than $110 a barrel. Wall Street analysts currently expect a 4.9pc year-on-year increase in the index’s earnings to $29.74 a share, according to S&P Capital IQ.

The energy sector has faced the brunt of the cuts, with analysts collectively forecasting a 20.6pc decline in earnings per share. Six months ago, the sector was projected to report a 13.4pc EPS gain. Over that period crude oil prices have fallen 56pc and the S&P 500 energy index has declined 22pc, trailing the 4pc return by the broader blue-chip index.

Revenues are also under pressure, with the energy sector expected to report four consecutive quarters of double-digit sales declines. Cuts to forecasts may still not be enough for companies to beat, says Nicholas Colas, chief market strategist at Convergex.

“Analysts are looking for guidance from companies in 2015 in the current environment,” he says. “We had a once-in-a-generation move in energy and the market needs some time to digest what it means for the economic picture and for earnings. And that’s not done yet.”

Citi has also noted that estimates remain too high and David Bianco, a strategist with Deutsche Bank, warned clients in December that ‘energy sector profits could be down much more than our near 30pc estimate’ if oil prices do not recover.

Much of the pain has been felt by small and midsized oil and gas companies which do not have the capital to withstand an oil price sitting below $50 for long. But blue-chip names within the S&P 500 have not been immune. General Electric warned that operating profits from its new oil services division would decline by as much as 5pc, while ConocoPhillips cut its capital expenditure plans by 20pc.

Shares of Caterpillar, the industrials group that makes equipment for mining companies and oil and gas drillers, slid more than 5pc on a JPMorgan report last week that warned its exposure to the energy market could affect upwards of 30pc of its revenues.

Mr Colas says there is a hope ‘the windfall’ from lower gas prices will buoy discretionary spending in the second half.

Published in Dawn, Economic & Business, January 19th , 2015

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