Stock Market: A Summer Damper

Although its progress might best be described as labored, the stock market had been inching higher over the last 8 weeks or so - posting a slow gain, but enough to gain 6 percent since its low for the year of 10,012 on April 20. Scarcely did we have time to appreciate this "stealth rally" before oil prices jumped briefly to $60.05 a barrel on June 23 - an intraday record that finally settled at $59.42 for the day. Seeing oil hit this $60 benchmark caused enough panic amongst investors to send stocks sharply downwards as the Dow Jones Industrial Average fell 1.6 percent posting its largest loss in 10 weeks. Standard and Poor’s 500 index and NASDAQ also declined. Oil prices continued to increase, hitting a new high with crude oil contracts for August delivery peaking at $60.54 per barrel on June 27 - a new high for front-month contract prices since trading began in 1983.

Brokers noted that oil has hit the psychologically important $60 mark before - it did back in April and on June 20, too - but the timing of these latest price hikes are technically significant with the July contract over and August now the front-month contract. Supply fears and speculation are triggering the price run-up, and analysts expect that crude oil prices in the $60 range will slow consumer spending, which will hurt stocks. Long-term interest rate hikes could add to the stock market’s woes, and the market expects to see the Fed raise rates at the end of June.

It probably didn’t help either that at around the same time, one of China’s state-controlled oil companies put in a bid for Unocal, a California based oil and gas company with extensive fields in Asia. This unsolicited bid not only put oil supply issues in the headlines again, but also caused major consternation on Capitol Hill as some lawmakers already rattled by China’s trade surplus, seized upon the news and anxiously voiced concern about economic and national security.

As the dust settled, a more objective view of the oil situation emerged with some market commentators noting that the real reason for the rally coasting to a halt is that the two-month long "stealth rally" is just running out of steam. Oil price jitters or no.

Other Wall Street gurus firmly believe that there is no oil shortage on the horizon, and no scarcity of refining capacity (another inflammatory rumor that has made the rounds recently). Many analysts agree that low interest rates are creating inflationary pressure and that inflation is the catalyst driving up oil prices. Escalating crude oil and gold prices are often viewed as key indicators that inflation (or fear of inflation) is increasing. Inflation usually hikes all commodity prices, but when combined with low interest rates, it creates a great opportunity for speculators to squirrel away more oil in the hopes of further inventory gains.

Most analysts expect the Fed to raise interest rates on June 30. Some believe that the Fed will stop increasing interest rates after this, but others hope to see Fed Chairman Greenspan signal a more aggressive stance to combat current inflationary threats - and increasing oil prices. If this scenario plays out, analysts are betting that oil prices will drop. The key question is: will the benefits created by lower crude oil offset the market’s dislike of rate hikes? The optimists say it will. Only time will tell.

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