Unfounded: US concern over rising oil prices

Reviewing the year thus far, stocks fell in January and then again since late April, driven mostly by investor concerns regarding inflation and the geopolitical events surrounding the war on terror. Late last year and early this year, many persons had not yet fully bought into the idea that the world’s leading economies were in recovery. With the highly critical jobs figures lagging, a degree of pessimism hung on early in the year, leaving many to question whether a jobless recovery would be successful. Lately, rising oil prices and an impending United States Federal Reserve interest-rate hike have been thrown in the pot to test the efficiency of the global equity markets.

Technical market indicators, which follow trends and try to forecast market movements, got pretty gloomy. Contrasted against the positive economic data, the poor technical indicators prompted discussion amongst analysts that the market was oversold and due for a bounce. Last week was definitely a bounce back. The question is whether the bounce is based in fundamentals or trend. The Dow Jones industrial average gained 2.2 percent, the S&P 500 gained 2.4 percent and the NASDAQ gained 3.8 percent. The NIKKEI and TORONTO were also up strongly for the week, 2.1 and 2.5 percent respectively. If it is that investors have stepped back up to buy in on value, the markets may well be settling into the next equity valuation growth phase.

Also playing on the money events were some weaker economic numbers last week and the US Dollar fell back again, losing almost two percent against the euro and even more against the pound and Japanese Yen. Where does this leave us? Here are some factual conclusions. The world’s major economies, led by the USA and UK are booming. Earnings performance and momentum has been and are expected to continue to be spectacular. Interest rates are going higher. Inflation is once again a concern, and something which will need to be watched and managed aggressively. The price of oil is also a concern, but should have less impact than the markets fear.

The hype in the US about gas prices fails to recognise that Americans enjoy some of the lowest fuel prices on the planet, and that with the exception of the airline industry, do not make up a significant portion of the overall expenses to really cause an impact. As a case in point, gas at the pump is only 3 percent of total consumer spending in the USA. Analysis shows that a $10 increase in the price of a barrel of oil will only knock about 1/2 percent off the US GDP growth. How can we say all these things are so, well let’s review the US economic statistics. GDP, the second quarter of 2004 has only one month left and the US economy will have grown at a phenomenal rate of 5.4 percent for a year. That is the strongest growth in over a decade.

Consumer spending is strong, and over all the bad times of 2000 to 2002, did not slow much, so why would high oil prices get a different reaction now. Manufacturing, is picking up sharply. Industrial production has grown at a 6 percent annual rate so far this year, and that is likely to rise in the near term. Global demand is strong for American brands despite the geopolitical flavour, and manufacturing employment is rising. Employment, the jobs figures have shown that growth is back in a big way. Nonfarm payrolls surged 625,000 in March and April, and another big gain for May is likely. Employment growth helps everything from consumer spending to reducing the budget deficit. Housing, the sector is slowing down, and this will only moderate overall growth a bit. Corporate Cash Flow is exploding and will boost business investment. Corporate Earnings have grown at over 20 percent the past three quarters and are likely to repeat this in the second quarter as well. A continuing boom in business investment will be evident over the quarters ahead. The US economy is firing on all cylinders. But to get a sense just look at Trinidad real estate and car sales to see the effect.

We remind readers that many of the financial news agencies are focused to selling news, not accuracy in news. They all have an agenda to create controversy to sell more business for them. Investors need to read past the sensational declarations and see how their neighbours, friends and family are living and spending there money. Although oil price is an important issue, we believe the recent hype on oil prices has over stated the impact it will have on economic growth. There is definitely legitimate concern about the outlook for inflation. Both the commodity prices (the pricing of raw materials) and core inflation (reflects the pricing trends in products for consumption) will see increases reflective of the new economic strength in the economy. This is normal and expected.

Interest rates also are going higher, but as we have stated in previous articles, at one percent, the US Federal Reserve can tighten 150 basis points before it gets to what history has shown is a low and simulative Fed Funds Rate of 2.5 percent. In conclusion, we believe that the foundation has been laid for the economies to move forward in a managed and steady growth cycle and that continued corporate performance will occur leading to increased values in the markets.

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