• Wealth Management

Rising Oil Prices Pose Risks

Many investors are ignoring risks to the economy and markets posed by higher oil prices. That could prove a mistake.

Investors have barely batted an eye this year amid steadily rising crude oil prices, up nearly 40% so far. Markets have easily digested that rise in part because it represents a recovery from the collapse in crude prices last fall, when demand weakened due to the slowing global economy (now healthier), and supply surged as the U.S. temporarily lifted some sanctions on Iranian oil exports.

A continued move higher may not be taken with such equanimity. Oil supply is likely to tighten over the next few quarters due to a number of factors, including the U.S. government’s recent decision not to renew waivers for Iran to export its crude oil, as well as plummeting output from both Venezuela and Libya.

Such conditions may push up crude oil prices even more, a risk for which investors should prepare now. Consider buying oil stocks, which should benefit from higher crude prices, as a defensive move, especially if you own a lot of high-priced growth stocks.

Below are three reasons rising oil prices may pose a growing risk to the economy and markets:

  • Higher oil is linked to rising inflation, which could prompt the Federal Reserve to raise interest rates.  Higher oil leads to broader price increases since it adds to transportation and raw materials costs for so many products. If inflation climbs, the Fed may need to raise interest rates later this year, a possibility that markets haven’t priced in—likely leading to more market volatility.

  • Rising crude prices would lift gasoline prices, which can lead to lower consumer spending. Gas prices in the U.S., which have already risen this year, could climb higher. If they rise more, currently high consumer confidence and spending could take a hit. Retail sales would likely suffer, which could hurt corporate profit margins for many companies. Year-over-year gas price comparisons don’t look that worrisome, but by this fall, that could change.

  • Higher costs of oil could imperil the fragile economic recovery in China and emerging markets, especially at this late point in the business cycle. If accompanied by a stronger dollar, that’s a double whammy for their consumers.

Even while stock and bond markets continue to rise, helped by an accommodative Fed and better underlying U.S. economic growth, I am somewhat skeptical that can continue for long. This year’s lurch higher in oil prices is one reason why. Investors who share my concern should keep a close watch on gas prices and consider hedging the risk of higher crude by purchasing shares in the oil sector.

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