Lower oil prices life stocks


Buoyed by declining energy prices and decent corporate earnings reports in the second quarter, the Dow Jones Industrial Average closed on Aug. 6 at its highest level since June. While market action is expected to remain choppy, investors should keep the bulk of their equity portfolios invested. The Forecasts’ recommended cash position remains at 15% to 20% of the portion of portfolios allocated to stocks for the long haul.

Oil spill
A major catalyst for the recent rally in stocks is the sharp decline in oil prices. Since posting a trading high of $147 per barrel on July 11, oil has declined roughly $30 per barrel.

The drop in oil prices has lowered gasoline prices. The U.S. average retail price for regular gasoline has declined for four consecutive weeks, falling to $3.88 per gallon in the week ended Aug. 6. That’s down $0.23 from the all-time high set July 7.

Oil prices, and by extension gasoline prices, are crucial to consumers. For every $0.01 increase in per-gallon gasoline prices, U.S. consumers pay $1.42 billion more a year at the pump. Lower oil prices also benefit commercial and industrial companies that have seen energy costs skyrocket in recent quarters.

A decline in energy and other commodity prices could potentially reduce inflationary forces, providing cover for the Fed to keep interest rates low.

Investors should be leery of viewing any short-term trend in energy prices as a permanent move. Energy prices can change direction quickly, and in a big way. Prior to the recent decline, oil prices had risen 53% since the end of 2007. And renewed economic growth — or increased tensions in the Middle East — could cause oil prices to move higher.

Because of that potential volatility, investors should not rest their hopes for higher stock prices solely on the direction of energy prices. That’s why the relatively solid showing for corporate profits in the second quarter is especially important. The impressive resiliency of corporate profits overall, coupled with the stock market’s favorable response to those profits, is particularly encouraging.

The decline in energy prices is a positive for the market. But even more important than energy prices are corporate profits. Fortunately, second-quarter profits have for the most part been better than expected, and the market’s positive response to those profits is encouraging. Holding some cash in reserve is prudent, but investors should not be bashful about buying quality stocks. One newcomer to the Focus List that looks especially attractive is St. Jude Medical ($48; NYSE: STJ)

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