Oil Soars, Stocks Plunge, Fueling Recession Fears
Life + Money

Oil Soars, Stocks Plunge, Fueling Recession Fears

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Could an oil price shock drive the U.S. back into recession? It’s possible. Americans are cheering the tide of democracy washing across the Middle East, but their joy may be short lived. With oil prices rocketing higher and stock markets reeling, consumers creeping out of their recession bunkers may find themselves hit by a double whammy of higher inflation and declining wealth. Depending on the severity of the oil production disruptions, the celebrations from Tunisia, Egypt and Libya could turn to lamentations at home, undermining Americans’ confidence and shifting the U.S. to the brink of the much-feared double dip.

In recent months, consumer confidence has recovered from the depths of the financial crisis, bolstered by renewed economic growth, some improvement in the labor market and by soaring stock prices. The latest index reading from the Conference Board  – in February - showed confidence at a three-year high of 70, much above the low of 26.9 recorded in March 2009. Still, the Conference Board’s research head Lynn Franco describes Americans’ current appraisal of business and labor conditions as “rather weak.” With consumer spending still making up some 70 percent of economic activity, shifts in sentiment are key.

Without a doubt, some of the improvement in how consumers are looking at their prospects has come from the steady advance in the stock market in recent months. The S&P 500 rose 30 percent from July 2 to February 15, with few setbacks; a recent Business Week piece points out that “stocks haven’t risen this much amid price swings this narrow since 1971.” Since the lows in 2009, stocks have surged over 90 percent..

Gains in investors’ stock portfolios have provided a major cushion against the continued decline in home prices. In January, sales of distressed properties pushed overall housing sales higher, but resulted in still-falling prices. The median home price dropped by 3.7 percent, to $158,800 – the lowest since April 2002. Analysts warned that the ongoing overhang of properties in foreclosure could lead to another 25 percent sell-off.  Since many families consider their home their most important asset, the continuing slide in value is a substantial dampener of sentiment, and of spending.

Looming in the shadows for the past several months has been the threat of rising inflation. Food prices around the world have soared as disappointing crops and rising living standards in many parts of the world have tightened supplies. Commodities prices have likewise moved higher due to rapid growth in China and other emerging nations as well as investors’ new-found enthusiasm for this asset class. In addition, prices for goods imported into the U.S. have risen, increasing in January 1.5 percent from December’s level.

Only in recent weeks have these pressures begun to affect shoppers in the U.S., as a growing list of consumer products companies, including McDonald’s, Victoria’s Secret, Whirlpool, Kraft and Hanes have announced price hikes. Such increases are almost certain to continue, and will accelerate if oil prices move higher for any period of time.

Given all these pressures, and remembering the still-high jobless rate, the recovery in the U.S. can be viewed as tentative. In describing the near-term outlook, the Conference Board’s economist Kenneth Goldstein makes that very point. Though he has just raised his estimate of this year’s growth slightly to 2.6 percent (nearly a full point lower than the Fed’s estimate), he cautions that he remains “more concerned about the sustainability of the momentum than the consensus.” He cites the anemic labor market and the struggling housing market as sources for his caution.   

He’s not the only Nervous Nelly. Federal Reserve Chairman Ben Bernanke sounds equally uncertain about the economy’s prospects, and makes that fragility the rationale for his continued enthusiasm for quantitative easing. Bernanke has referenced the recent stock market advance as proof that the easing program is successful and necessary.  Somewhat controversially, he links rising stock prices with spending, perhaps seeing stock gains as especially vital with housing still depressed. For sure, the Fed’s program of infusing hundreds of billions of dollars of liquidity into the system is predicated on the possibility that our recovery could still be derailed. 

An oil price shock, and consequent slump in share prices -- just in the past few days prices are off nearly 3 percent -- could turn that fear into a reality.