Equity experts say the surge in oil prices isn’t yet a threat to the health of the stock markets. But the changing nature of those price increases is making many of them increasingly nervous.
While commentators generally agree that the price rise in recent months hasn’t been big enough or fast enough to derail investor confidence in an economic recovery, they warn that the heightened fears surrounding Iran and the Middle East have added a new element of investor risk to oil’s upward march.
West Texas intermediate oil briefly topped $110 (U.S.) a barrel Thursday, while the European benchmark Brent crude rose above $125 a barrel in after-hours trading, following reports by Middle Eastern news organizations of a pipeline explosion in Saudi Arabia, that were later denied by Saudi officials.
“The bulk of the rebound in oil prices from their October lows can still be explained by increased optimism about the prospects for the global economy, reflected also in the rebound in equities. This much of the move is essentially benign,” wrote Julian Jessop, chief international economist at Capital Economics in London, in a note to clients. “However, the additional premium in the oil price for the heightened tensions with Iran … clearly needs watching.”
In general, rising oil prices are associated with higher stock-market levels, not lower ones. Both markets tend to reflect the underlying strength in the economy – and, thus, typically both rise when global growth prospects are improving. That, economists say, is what has been happening in recent months; oil, like stocks, has been a reflection of rising demand – not an impediment to it.
But with the growing tensions between Iran and Western nations surrounding that country’s nuclear policies now ramping up fears of a Middle East clash that could throw supplies into disarray, market watchers are hearing echoes of this time last year, when Libya’s unrest sent oil surging. The global economy and stock markets – even the oil-rich Toronto Stock Exchange – subsequently went into a funk.
“With markets at their highs, oil prices marching higher, and uncomfortable rumblings from the Middle East in the background, investors are wondering if they have seen this movie before,” said Goldman Sachs strategist Kamakshya Trivedi in a research note.
“There is no question that rising fuel prices pose a risk to economic growth. Unfortunately, there are no hard and fast rules as to when a choke point will be reached,” Montreal-based BCA Research wrote this week. “The pace of the up-move bears close attention, as the faster prices climb, the more damaging they will be to confidence.”
The pace this winter has been much slower than last winter, when U.S. gasoline prices spiked more than 50 per cent. So far this winter, U.S. gasoline prices have risen about 30 per cent, while the price of Brent crude is up about 20 per cent.
“The current pace is well short of the doubling within a year or two that has previously been associated with a drop back into recession,” Mr. Jessop said.
But experts warned that if the Iranian troubles were to escalate, oil could shoot above $150 a barrel – and that would change the outlook for both the economy and stocks.
Barry Knapp, head of U.S. portfolio strategy at Barclays Capital in New York, argued that an oil-fuelled slowdown in global economic activity would likely force the U.S. Federal Reserve Board to consider further policy easing to stimulate the economy – and that would likely deal a considerable blow to equity markets.
“Global monetary policy easing, another factor often cited by investors as a reason for optimism, could also be complicated by rising energy prices,” he said in a note to clients. “We suspect that hints at further easing from the Fed would lead investors to sell the dollar, buy oil, and rotate out of cyclical sectors, causing the 2012 equity market rally to likely stall.”