Oil woes cloud the markets
Stock traders shrug off more heartening economic happenings
In the Magic Kingdom, at least, things make sense. Walt Disney Co. shocked investors last week by posting a stunning 71 percent increase in quarterly profits, thanks primarily to increased theme-park attendance and strong cable TV returns. Disney stock proceeded to rise accordingly, ending the week up 4 percent.
Alas, investors learned last week--just as adolescents inevitably do--that the larger world is quite unlike Disneyland. Indicators continue to show both the economy and, especially, corporate profits, growing robustly. The heartening April employment report of two weeks ago was followed last week by more good news on trade, the labor market, and corporate profits. "There are plenty of signs of an economy that's gaining momentum," says Stuart Hoffman, chief economist at PNC Financial Services Group.
The stock market, however, would have none of it, seesawing wildly during the week between triple-digit losses and moderate gains. After five turbulent days, the Dow was down 105 points for the week. More broadly, however, the S&P 500 index of large companies fell only 3 points.
Rate fears. The obvious explanation is the one endlessly repeated on CNBC and the financial pages: that investors are blanching at the idea of the Federal Reserve raising interest rates, which could slow the economy and make bonds more competitive with stocks. But the relationship between rates and stocks is a muddled one. As an analysis from InvesTech Research points out, the Fed has engineered 10 rate-hiking cycles since the 1950s. In three of those, stocks declined sharply over the next 12 months. But in six cycles, stocks experienced double-digit gains.
To A. G. Edwards chief equity strategist Stuart Freeman, 2004 is looking a lot like 1994, when the Fed raised rates in a year marked by a bond-market sell-off and a stagnant stock market. "It was really a transition period where the market had to get its arms around the fact that the Fed was raising rates," Freeman says. "But that was not enough to halt the economy, and the market eventually started moving ahead." Indeed, 1994 was followed by five years of huge gains in stocks.
A less obvious explanation for market nervousness is inflation, signs of which are re-emerging after years of dormancy, much like the cicadas now infesting large swaths of the East Coast. The latest was the index of April consumer prices, excluding energy and food prices, which rose more than expected. But Fed Chairman Alan Greenspan seems unworried: He omitted the topic altogether in a speech to a Chicago conference on Thursday, choosing instead to wax nostalgic about his youthful ambitions to perform "with the likes of the Glenn Miller Orchestra."
Still, a larger concern for the economy going forward is energy or, more specifically, oil. The price of oil futures, not adjusted for inflation, hit a record Friday, rising above $41 per barrel. High oil prices increase costs for U.S. businesses and, more important, cut into consumer spending. No respite seems in sight. Gasoline prices will average $1.94 a gallon this summer and at times could top $2, according to Department of Energy projections, well above what was expected just a month ago.
Expectations, low inventories, and dicey geopolitics are behind those high prices, says Philip Verleger, energy economist and senior fellow at the Institute for International Economics. Expecting oil prices to drop, U.S. refineries held off on beefing up inventories last autumn. Rising demand, much of it in China and the United States, kept prices high, and now there's not enough gasoline to meet it. Recent political violence in Saudi Arabia, which supplies 11 percent of the world's oil, just makes matters worse. How high can oil and gas prices go? "We don't know," says Verleger, "but the sky's the limit."
So even if Saudi Arabia did promise President Bush to pump more pre-election oil, as detailed in Bob Woodward's recent book, Plan of Attack , it may not be enough to ease the pain at the gas pump. For the president at least, that particular kingdom may have run out of magic.
With James M. Pethokoukis
This story appears in the May 24, 2004 print edition of U.S. News & World Report.
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