The energy market has dominated the news lately, with plunging oil prices translating to cheaper gasoline and lower heating costs for most Americans during the cold winter months. Yet perhaps the most surprising thing about energy's decline is how little impact it has had on the broader stock market. Given just how important energy has been to the U.S. economic recovery, understanding oil's minimal affect on stocks is vital to projecting the future course for both markets.
Source: Flickr/Lindsey G.
A tale of two markets
Stocks jumped out to a strong start on Monday, reversing some of last week's declines as investors looked forward to this week's meeting of the Federal Reserve's Open Market Committee to get their next reading on the future direction of monetary policy. The euro rebounded slightly as well, removing some currency uncertainty from market participants' minds as U.S. investors hope multinationals' foreign earnings growth will eventually stop facing headwinds from the strong dollar. As of 11:10 a.m. EDT, the Dow Jones Industrials (^DJI +1.47%) were up nearly 190 points, leading broader-based indexes higher.
Yet the oil pits showed a very different picture of market conditions. The price of West Texas Intermediate crude fell below $44 per barrel, marking a new six-year low, and Brent crude went under $55 per barrel. Huge demand for storage facilities suggests a glut of energy products in the U.S. -- and as more investors seek out the rewards offered by the current price structure in the futures markets, the domestic energy market's supply overhang could worsen in the short run.
Why oil hasn't made stocks crash
Within the energy industry, the impact of falling crude has been huge. Dow components ExxonMobil (XOM +0.29%) and Chevron (CVX +0.68%) have fallen 20% to 25% since last July, and the carnage among smaller exploration and production companies has been much more substantial.
Across broader market benchmarks, though, energy's influence isn't as great as you might expect. Exxon and Chevron make up less than 7% of the Dow's weight, with the two stocks' prices giving them roughly proportional weight to the other 28 members of the average. Even when you look at broader indexes like the S&P 500 (^GSPC +0.54%), energy stocks only represent about 8% of the total market. Small-cap indexes have even less exposure to the industry, with energy companies contributing less than 3% of the Russell 2000's market cap.
Photo credit: Flickr/Paul Lowry.
Also, falling oil prices aren't bad for the entire energy industry. Refiners have particularly benefited from the widening spread between domestic and global crude prices, as supply concerns are much more prevalent within the U.S. than in foreign markets. Prospects for pipeline and other infrastructure-related companies have largely remained stable, as the need to transport energy products hasn't changed dramatically with price movements.
Finally, investors need to keep in mind that many industries benefit hugely from lower energy costs, and their share-price gains can help offset the losses among energy stocks. Railroads and airlines are some of the best examples of this phenomenon, as both industries burn huge amounts of fuel. But even consumer stocks have enjoyed some secondary effects from lower gasoline prices, as shoppers have more discretionary income to spend.
The energy-market crash has certainly taken its toll on the sector. But for investors with diversified exposure across the market, energy's fall hasn't fully routed stocks -- and it doesn't appear likely to do so in the near future.
