Oil, the Stock Market and the Economy
Mar 8, 2011
Posted by Jody Eisenman | Filed under Uncategorized
In the past month, the price of crude oil has risen from ninety dollars/barrel to about $105. This is due mostly to the political unrest in the Middle East, which has been discussed here in the last few weeks. The Egyptian and Tunisian governments have been overthrown, and Libya is engaged in a civil war which has claimed hundreds, or perhaps thousands of lives. Although the oil production from Egypt and Tunisia are not that significant, Libya is sitting on the largest oil reserves in Africa. In addition, Gadhafi is known as an unpredictable despot who is not beyond using the “Samson option”. What that means is that if he felt he was going down, he might very well act to destroy his country’s oil reserves with him. However, the real danger is if the unrest spreads to Saudi Arabia. So far, protests there have relatively benign, but as we have seen, the situation could change overnight. Consequently, you have various talking heads on CNBC stating that oil could go to $200; then you have others who think the price is going right back to $80. The last time oil spiked like this was in the summer of 2008, when the stock market and the economy were reeling from the housing crisis. By July of that year, oil had gone to over $125/bbl. However, most analysts believed that this was true to traders and not political events. As such, the price quickly dropped back down into the thirties by the end of the year. What is indisputable is that stock prices tend to trade in inverse of oil price spikes. That is to say, when oil shoots up, stock prices tend to drop. The reason for this is that increasing oil prices lead to higher gasoline and energy prices, and thus slows our economic growth rate. Currently, OPEC is considering ramping up production in order to reduce prices, and the Obama administration is considering whether to tap our strategic oil reserves. Meanwhile, gasoline prices are soaring, with the average price per gallon exceeding $3.50 according to the Automobile Association of America (AAA).
Meanwhile, the effect on stock prices has been mixed. Although the market advance has slowed, the S & P 500 still closed at 1310 yesterday. This is only 34 points off its 52 week high, and 300 points off its low. In addition, we are now almost double where we were at the market bottom of March 2009. What is keeping the market up? I believe it is a combination of three factors:
1. Low interest rates. As bond yields, especially treasuries are so low, investors look for alternatives in equities. Currently, one year treasury rates are around .25%; CD and money market account rates are anemic.
2. Corporate profits. As the economy recovers, we have seen corporate profits increasing rapidly in a quarter by quarter and year by year comparison. What is still puzzling is that the unemployment rate has remained around 9%. Unfortunately, I think that while many companies laid workers off in 2008 and 2009, they have been very slow to rehire them. This could be because they are being cautious, or perhaps they feel that the incremental cost of hiring people does not bring about a corresponding increase in profits.
3. The Federal Reserve. The much touted Quantitative Easing Plan (QE2) has definitely led to higher stock prices. As the Fed continues to buy bonds and pump dollars into the market, prices have soared.
