Debunking The Myth Of An Oil-Driven Market Sell-off [United States Oil Fund LP (ETF), Energy Select Sector SPDR (ETF)]

Wall streetThis year opens with some big market fluctuations, but blaming it all on the descent in oil prices is misguided. Here is a closer look at the many ways that lower energy prices help U.S. consumers.

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Following the recent spike in market volatility, a quick reading of the financial press would have you believe that all the woes in the world are attributed to the plunge in oil prices. This is a curious conclusion. While lower oil prices are a negative for Russia, Venezuela and highly leveraged oil and gas exploration and production companies, the drop in energy prices is a positive for the economy, particularly consumers.

The average American household uses roughly 600 gallons of gasoline a year. A $1 drop equates to around $50/month of extra disposable income. Another way to measure this is to look at what is spent at gas stations versus other retail establishments. Over the past decade, on average roughly 10.5 percent of overall retail spending occurred at gas stations. Last November, that percentage dropped below 9 percent, the lowest level since February 2009 (and that is not accounting for the dramatic fall in oil prices over the past six weeks). The money saved at the pump typically winds up in other places.

This windfall is likely to have the biggest impact with middle income and lower-middle income families. According to a Bank of America/Merrill Lynch survey, in 2012 households earning less than $50,000 a year spent 21 percent of their after-tax income on energy, compared to 9 percent for those earning more than $50,000. This is important as lower income households have a higher propensity to spend. It should also be noted that many families are not only getting a boost from lower prices in gasoline, but also from natural gas, which heats about 50 percent of U.S. homes. Natural gas prices recently dipped below $3 per million BTUs for the first time since 2012.

Besides flattering household cash flow, the drop in energy prices supports consumption through a second mechanism: higher confidence. Last month the University of Michigan Consumer Sentiment Index hit its best level since early 2007. This jump in sentiment partly reflects fewer concerns regarding inflation. U.S. consumers have a very intimate awareness of gasoline prices, often basing their views on inflation disproportionately on food and energy prices (see Figure 1).

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