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Portfolio > Economy & Markets > Stocks

Should Investors Take Advantage of Cheap Oil?

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Market watchers are divided on where the global economy may be headed in the short term, but they do agree on energy stocks: Low oil prices make it a good buying opportunity, they say.

Mark Luschini, chief investment strategist of Janney Montgomery Scott, argues that concerns over weak economic growth may be overstated. A better growth picture, he adds, means good news for energy firms

“Despite weak data points, though, global economic growth should improve,” Luschini argues in his latest economic overview, released late Monday.

“Global sales appear solid over the last six months, and global factory output should close the gap,” he said. “September manufacturing numbers are encouraging, and consumer spending should accelerate with oil prices down.”

The strengthening labor market, low interest rates and weak energy prices should boost growth in the U.S., Luschini explains.  “Despite weak September retail sales numbers, sales are still up 4.5% year over year on a trend basis. If consumers continue to benefit from declining oil prices, confidence should rise.”

The strategist acknowledges that there’s some risk the U.S. could be hurt by weak global economic growth. However, current U.S. economic data “does not yet reflect this,” he says.

“With oil prices down 25%, global consumer spending should accelerate,” Luschini added. “Solid September global auto sales support this view.”

In addition, he points out, low inflation gives global central banks more flexibility and weakens government fiscal drag.

The situation presents investors with a good time to jump in.

“Despite oil prices being hit hard over the past few months, some indicators have historically proven this time to be a contrarily bullish time to buy the energy sector,” the strategist wrote. “Unless these indicators weaken enough to signal that a global recession is a serious threat, then at least a playable rally should ensue before re-evaluating an overweight stance.”

Complex Picture

Meanwhile, LPL Financial (LPLA) Chief Investment Officer Burt White and market strategist Jeff Buchbinder make their case for energy investments in a report shared early Tuesday.

The two experts argue that the current oil sell-off is “overdone” and that oil should find a price floor “in the low $80s.”

They base their forecast on an expectation that global growth should improve, despite weakness in Europe.
“Energy-service stocks are particularly oversold and may be attractive as the services-intensive U.S. energy renaissance continues,” White and Buchbinder said.

As Luschini implies in his report, oil has a big influence on the economy, these two experts note.

First, consumers spend about 4% of their income on energy. Second, energy accounts for roughly a quarter of all capital spending globally, which is more than any other sector. And third, oil influences transportation.

West Texas Intermediate, the LPL strategists point out, has fallen about 25% from its summer highs. The sharp decline, they say, coupled with firm demand in the U.S. and China, as well as an expected demand boost from lower prices “should reduce the chances of further material downgrades to global demand expectations.”

Further price drops are unlikely, the LPL report says, because oil is now “deeply oversold.”

“Based on the 14-day relative strength index (RSI), a measure of oversold conditions, oil has reached oversold levels not seen since May 2012. Based on historical data, price declines of this severity leave a high probability of a potential oversold bounce or move higher in price,” White and Buchbinder said.

Bumpy Road Ahead?

Still, the two experts say, the road to higher oil prices is not necessarily a smooth one.

“Additional pipeline development, export-friendly policies, and stronger demand are needed to help clear out excess inventories in the United States,” they wrote. Plus, the global market for oil appears to be “slightly oversupplied in 2015.”

Furthermore, a prolonged recession in Europe could put more downward pressure on global oil demand.

Still, the experts state that the energy sector “may be a good place for investors to look for bargains now that the market is pricing in much lower oil prices and valuations have fallen.”

They foresee higher oil prices as supporting “an eventual rebound in energy stocks in the coming months, further bolstered by extreme oversold conditions and favorable seasonality,” according to their latest report.

Master limited partnerships (MLPs), particularly pipeline MLPs, “remain well positioned” to take advantage of the opportunity in the energy services sector.

Overall, firming global growth and tighter OPEC supplies should support oil prices and demand, White and Buchbinder stress: “Booming U.S. production and a global price war present manageable risks, in our view, and we would expect the market to find its supply-demand equilibrium — and in turn, more solid footing — in fairly short order.”


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