Market implications of a prolonged spike in oil prices
While a short-term spike in oil prices due to declining production in northern Iraq is not a major threat, a prolonged price rise would put additional pressure on the global economy, including on U.S. consumers, who are still operating in a mode of caution.
Market Realist – The Consumer Confidence Survey by the University of Michigan receded slightly in the latest reading, reversing the rebound we observed in April.
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As of early this week, the violence in Iraq showed no sign of abating and it appeared that the crisis in the Middle East isn’t likely to be resolved quickly.
Perhaps even more importantly, in addition to the short-term impact on oil production, the insurgency in Iraq and civil war in Syria have the potential to dramatically alter national boundaries in the Middle East.
In other words, there may be longer-term implications and potentially significant changes to international borders. Under this scenario, energy prices may remain elevated for a prolonged period of time, which could add additional pressure to several major economies, including the United States, China and India.
As for what this means for investors, higher oil prices, coupled with still reasonable valuations in the energy sector, support a continued overweight to energy stocks. At the same time, higher oil and gas prices represent yet another headwind for a U.S. consumer already struggling with slow wage growth and high personal debt. In a world of modest growth and a strapped consumer, I believe a cautious view toward consumer stocks is warranted.
Market Realist – The graph above shows the reaction of equities within the energy and consumer staples sectors. While equities as a whole rebounded, energy sector stocks climbed much higher as consumer staples sector stocks remained in line with the broader market. Learn more about the implication to oil markets by reading Must-know implications of the tumult in Iraq for oil prices.
Sources: BlackRock, Bloomberg
Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist.