Oil prices have risen as investors’ appetite for risk assets has grown. Despite steadily rising crude oil prices, which have risen nearly 40% this year, investors have barely noticed. That rise has been easily digested by markets, in part because it represents a recovery from last fall’s collapse in crude prices, when demand weakened due to a slowing global economy (now improving) and supply surged as the US temporarily lifted some sanctions on Iranian oil exports.
A continuation of the upward trend may not be possible with such calm. Oil supply is expected to tighten in the coming quarters as a result of a number of factors, including the United States’ recent decision not to renew waivers allowing Iran to export crude oil, as well as falling output from Venezuela and Libya.
Such circumstances could push crude oil prices even higher, a risk that investors should be aware of now. If you own a lot of high-priced growth stocks, consider buying oil stocks as a defensive move, as they should benefit from higher crude prices.
Rising oil prices may pose a growing risk to the economy and markets for three reasons:
Inflationary pressures are linked to higher oil prices, which could prompt the Federal Reserve to raise interest rates. Because it adds to transportation and raw materials costs for so many products, higher oil prices lead to broader price increases. If inflation rises, the Fed may be forced to raise interest rates later this year, a possibility that markets haven’t factored in, potentially resulting in increased market volatility.
Increasing crude prices would raise gasoline prices, potentially reducing consumer spending. Gas prices in the United States, which have already risen this year, may continue to rise. If they continue to rise, consumer confidence and spending could suffer. Retail sales would almost certainly decline, putting pressure on many companies’ profit margins. Year-over-year gas price comparisons don’t appear to be alarming, but that could change by this fall.
Higher oil prices could jeopardize China’s emerging markets’ fragile economic recovery, especially at this late stage in the business cycle. It’s a double whammy for their consumers if it’s accompanied by a stronger dollar.
Even as stock and bond markets continue to rise, aided by a dovish Fed and stronger underlying US economic growth, I am skeptical that this trend will last. One reason for this is the sharp increase in oil prices this year. Investors who share my concern about rising gas prices should keep a close eye on the market and consider hedging the risk of higher crude by purchasing oil-related stocks.
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