How Oil Prices Are Affecting the Stock Market

I just came back from a week’s vacation. My family and I took a road trip — boy, were the exorbitant gas prices at the pump difficult to stomach! Two years ago, it cost me $50 to fill up my tank. Today, given the rapidly rising gas prices, it costs me a whopping $100.

 On Monday, the aftermath of Hurricane Katrina was clearly being felt at the pumps, with the average price of gasoline surging to $3.20 a gallon, up $1.35 or 72% versus a year ago, and up over 30% since the hurricane. Like most people, I have no choice but to live with it, even though it really impacts the wallet. I do drive less, these days, which is ironically good for the environment.

 With many people on a limited budget, however, the higher allocation required for fuel costs has reduced the amount budgeted for discretionary spending. On the weekend, I was talking with a friend of mine who receives a gas allowance of $0.35 per mile at work, but he was complaining that it has not increased in three years, despite steadily rising fuel costs.

 The impact of higher gas prices could take a toll on the economy and GDP growth. Higher prices will translate into lower spending on discretionary buying such as travel, clothing, restaurants, and entertainment.

 What this means for the stock markets can already be seen in the retail sector, where many major retail chains, including Wal- Mart Stores Inc. (NYSE/WMT), have already warned about weaker sales. The concern is with the holiday shopping season coming up, we could see reduced spending.

 If gas prices remain high, which they likely will, I would expect soft retail sales for the fourth quarter. If you own any retail stocks, especially the higher end retail stocks, you should take note and consider reducing your exposure. Of course, the same applies to any sector in which fuel is a major expense, such as the transportation sector.

 The Dow Jones Transportation Average has failed to hold above 3,800 on three separate occasions over the last year, and it is currently in a near-term downtrend that could drive the index down to test technical support at 3,600, followed by 3,400. Monitor this.