Does The S&P Top 1,000 Before Crude Trades Above $100?

There may be some exceptions to the rule that crude and the stock market both trade substantially higher for a long period of time. The price of oil is bound to be seen as a harbinger of inflation and the enemy of consumer and business discretionary spending. Households paying $3 for gas are not likely to return to malls and showrooms. Airlines, truckers, and firms that rely on oil and petrochemicals will have narrowing margins or, in some cases, growing losses, if oil continues to rise at what has been a remarkable pace.

Crude passed the $68 line and has roughly doubled its price since early this year. It may not be near the $147 where it traded last summer, but, by most measurements, the economy was not in the worst part of the recession then. The trough of the economic downturn may be a month or two behind its worst month at this point, but the recovery is fragile, if it is a recovery at all. A sharp increase in oil throughout the summer could crush any turnaround and take the economy back to where it was in the first quarter. That would have a number of effects, not the least of which would be to trump any significant benefits of the Administration’s stimulus package which would make the attempt to increase the national deficit look foolhardy.

The press and experts continue to insist that the oil rally does not have legs. It should not have them anyhow. Supply appears to be abundant. OPEC did not make a production cut at its most recent meeting and signaled that it has no intention of doing so in the near future. The American, European, and Japanese economies are still too feeble to contribute to a surging demand for oil.

The case for oil moving much higher has to balance two theories, neither of which may be true. The first is that demand in emerging markets such as India and China is increasing much faster than forecast as those nations quickly move toward an economic recovery. The second is that the low price of oil over the last three quarters has caused a large cutback in exploration and refining capacity. Oil prices might move much higher if the majority opinions about both crude supply and demand are true.

The case for the stock market going higher should be better than the one for more expensive oil, at least on the face of it. The S&P 500 is only up 1% in 2009, after a nauseating sell-off at the end of the first quarter dropped as low as 667. It now trades at 943, so 1,000 is easily within range. News about May unemployment that is much worse than expected could bring the market down. The only other economic force that is likely to undermine its advance is the price of crude.

Most experts would say that oil and the market are both up because of irrefutable signs that the US and global economies are improving and may actually be growing by the end of the year. Oil may not be a proxy for inflation but it is a reasonable stand-in at times, and one of those times is during the next quarter.

Stockholders and oil speculators cannot both win a race to much higher ground. Sometime in the next month one or the other market is going to push sharply higher over a matter of a few days. The other market will end up being flattened in the process.

Douglas A. McIntyre