Oil PricesSubmitted by Destination Wealth Management on November 15th, 2018
Oil prices continue to be under pressure on concerns about global growth and end user demand. Prices have fallen and energy costs are declining for both consumers and businesses. It is logical to ask what the impact of falling prices might be on the overall economy
One significant input in the inflation equation is the price of energy. Energy costs impact both businesses and consumers and tends to be one of the factors that leads to higher prices for goods and services. If energy prices rise, the Federal Reserve pays close attention to this input cost as history suggests this is a precursor to inflation. Likewise, if energy prices fall the Federal Reserve notes this as they make judgments about future increases in interest rates.
Falling energy prices also impact economic growth. If consumers and businesses have more funds to spend on other items, this tends to be a positive for growth and can be a stimulative impact on economic expansion. This stimulus tailwind can offset a portion of the reduced inflation impact. This is where it gets a bit complicated; lower energy prices reduce inflation pressure but also provide for the possibility of higher growth because of lower energy costs.
The net result of lower energy costs in our view is a positive for both economic growth as well as the outlook for inflation. What is important in this current environment is the direction of interest rates as dictated by the Federal Reserve. If the Federal Reserve continues to raise interest rates at a rapid pace, it could impact the economy by reducing expansion and potentially moving the economy towards recession. Any data that might cause the Federal Reserve to pause in its current interest rate path could very well be a net positive for the overall economy.
Lastly, while lower energy costs are positive for the overall economy, they are not such good news for energy companies. Companies that focus on exploration will likely be under pressure as the profit incentive will be reduced if energy prices remain at low levels. Throughout the energy supply chain, lower prices will likely negatively affect most energy companies. As these companies are a significant part of the economy, any dramatic drop in prices (such as several years ago when oil prices fell to under $30 per barrel) could be a negative for the market.
We are not surprised energy prices are under pressure. Alternative energy, increased supply, a weakened Organization of the Petroleum Exporting Countries (OPEC), and global economic uncertainty (particularly in China), all make for an environment where energy prices are impacted. Assessing this information and its impact on investment strategy continues to be one focus of DWM as we invest portfolios. We will adjust as needed.
If you have any questions about this information, please let us know. Happy to answer any questions you might have.