Economic Body Blows

When Oil hits $120

LONDON — Major banks warned on Thursday OPEC needs to act as oil prices near levels that could derail economic recovery and that an output loss from another producer after Libya would lead to global shortages and demand rationing.

Goldman Sachs issued a note saying the world would not be able to cope with another Libya-style oil production outage as Brent oil prices rallied by over US$8.50 a barrel to near US$120 a barrel amid unrest in Libya.

Key Libyan oil player, Italian oil firm ENI, said the OPEC member had lost three quarters of its production.

"The market cannot accommodate another disruption, in our view, with the problems in Libya potentially absorbing half of OPEC's spare capacity," Goldman Sachs' analyst Jeffrey Currie said in a research note.

"This makes the risks now associated with further contagion much higher than they were several days ago.....

Deutsche Bank said oil above US$120 a barrel would be an inflection point for global economic growth.

"US$120/barrel is the level that oil as a share of global GDP starts to move above 5.5% of GDP, which has historically been an environment where global growth has come under pressure."


The high price of crude is rapidly making mincemeat out of the economy. As we noted back in January, in the post The Gasoline Indicator, as gas prices rise above the $3.00 to $3.50 per gallon mark, discretionary spending rapidly comes to a standstill. If crude continues to remain elevated at its present level, gasoline will likely rise to $4.00 or more.

As we found out in 2008, fuel prices at this level will rapidly deflate an economy that is so heavily dependent on automobile driving suburban consumers.

We noted in an earlier post that crude price over $90 per barrel fuel price inflation and act as a substantial drag on the economy. As consumers slow their spending, retailers lose pricing power and are squeezed by increased product costs.
Net result - lower earnings for corporations and a reduction in the "E" part of the market's P/E ration.

So the question for market watchers is this:
Will investors be satisfied with even lower earnings and returns and a market that carries a higher P/E ratio, or will the market drop to compensate for lower earnings in the next few quarters?


  1. Municipal bonds are headed for a blood bath. Of course, when the muni-carnage gets underway, attention will then shift to the next shoe to drop: treasuries. Things are set to get very interesting in 2011.



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