A 3-Sentence Explanation Of What Crashing Oil Prices Mean For America

The price of oil has crashed to multi-year lows.

Falling energy prices are good for the US consumer. But they’re bad for the big US energy producers.

Remember, technological advances in hydraulic fracturing have sparked the US shale energy boom, which has been a source of economic growth thanks to capital capital expenditures and job creation in the industry. Low oil prices puts this story at risk.

So, net net, are falling prices good or bad?

Charles Schwab’s Liz Ann Sonders offers some simple maths that puts it all into perspective. In three sentences:

Consumer spending represents 68% of the US economy. Oil and gas capex represents about 1% of US GDP and less than 9% of US total capex (which in turn represents about 12% of US GDP). Therefore, the benefit of lower energy prices to the consumer and many businesses greatly outweighs the significant hit to energy companies and/or energy-oriented capex, especially in energy-oriented states.

So unless you’re heavily exposed to energy capex, falling energy prices are overwhelmingly good.

At a media event on Thursday, Sonders’ colleague Jeffrey Kleintop noted that historically, consumers spend every penny of the savings they get from energy.

Regarding capex, keep in mind there are all sorts of industries that aren’t in the oil drilling business. If anything, lower energy costs will encourage them to spend more.

“US domestic capex has grown by more than $US600 billion over the past four years, with $US100 billion of that being energy-oriented,” Sonders said. “One can argue that much of non-energy capex would benefit from reduced operating costs courtesy of lower energy prices.”

And the list of positives goes on.

“Lower energy prices also hold down overall inflation, which is a plus for both the US economy and stock market,” Sonders added. “Lower inflation has historicaly meant higher equity valuations. In fact there is a direct inverse correlation between the energy sector’s weight in the S&P 500: a lower weight, typically as a result of lower energy prices, has led to higher overall S&P 500 P/E ratios and vice versa.”

In aggregate, lower prices are very clearly good for both the US economy and the overall stock market.

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