Oil, the Stock Market, the Economy and Where We’re Headed

Okay, so the stock market has told us that it doesn’t like crude oil above $125.00 a barrel. Up to that level, the stock market is telling us that oil is not a big factor for the stock market. But oil at over $125.00 a barrel is a problem for the economy. My charts tell me that $125.00 is the magic number for the relationship between oil, the stock market and the economy.

What stocks are hit the most when oil prices rise rapidly? Companies like the airlines, gambling, hotels, recreation services, travel and tourism all decline when oil prices rise, as their profit margins fall, because consumers cut back on travel. All the industries I’ve mentioned above are included in the Dow Jones U.S. Travel & Leisure Index — and that index was hit very hard yesterday, down 12.14% in a single day.

If we look past the obvious — the companies that are negatively affected by higher oil prices — I believe that the stock market has another more serious concern: higher interest rates. Higher rates affect not just the travel companies but also all the industries that make up the bellwether Dow Jones Industrial Average.

The reality of oil prices is that they are higher because the U.S. dollar has fallen so much in value against other world currencies in the past five years. America still pays OPEC greenbacks for the oil it buys. The rich OPEC members either convert those dollars into the currencies of their countries or they invest the U.S. dollars they receive for their oil back into America. But why invest American dollars back into the U.S. only to see those dollars becoming worth less and less as time passes?

The government and the stock market know all too well that the only way to lower oil prices is to increase the value of the U.S. dollar. And the only way to raise the value of the U.S. dollar is to raise interest rates in the U.S. — this is the stock market’s big fear.

The Fed has done its best to reduce interest rates to help American consumers suffering from the housing market downturn. (I’m a big fan of Ben Bernanke.) Higher interest rates though will slow the economic recovery the Fed is hoping for. On the other hand, higher oil prices will hurt the economy severely. The U.S. economy cannot operate with the price of oil between $150.00 and $200.00 a barrel.

When I look at the bond market, I see a rare case where the bond market is not “seeing it” as the stock market sees it. Bonds are holding steady and not falling as expected in light of the possibility of higher interest rates. (This is very curious for me and I continue to monitor the bond market closely.)

These are extremely interesting and difficult times for the U.S. economy and for investors. We’ve gone from fallout in the housing market to fallout in the mortgage/banking industry to dangerously high oil prices. How will it all work out? Hopefully, in these writings, I’ll help you with the answer before it happens.

(As a side note, I remember all too well Texas in 1986 when oil prices fell below $10.00 a barrel: most of the major oil companies were going broke there and Exxon Mobil Corp. was complaining it couldn’t make money at $10.00 barrel oil. My, how times have changed… with Exxon now making close to $1.0 billion a day from higher oil prices.)