Making Money Alert: The Oil Threat

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If you’ve paid a visit to the pump recently, I don’t have to tell you about the cash you’ve had to hand over to fill your tank. Gasoline prices, of course, are directly connected to the price of oil, and the cost of a barrel of crude also has surged this year. After hitting a high for the year of $110, prices now are hovering around the $106 per barrel range, and that’s beginning to have a negative effect on the economy.

If history is any gauge of what might be in store for the future, then a recession spurred by high oil and gasoline prices could be right around the corner. I say that because every time we’ve had a significant spike in oil prices, it’s been a precursor to an economic downturn. I’m old enough to remember the oil shock of 1973 that sent the economy — and the stock market — tumbling. More recently, in early 2008, we saw oil prices surge to $140 per barrel and gasoline prices rise above $4 per gallon.

The 2008 oil spike was followed by one of the worst economic downturns in U.S. history. Although oil and gas prices were only part of the equation that led to the 2008 recession and subsequent market collapse, the bite high energy costs can take out of an economy –and out of corporate profits — cannot be denied.

Conversely, when oil prices fall drastically we usually see the economy and the markets spike. This situation was the case in the late 1990s when oil fell to $12 per barrel. In 2009, oil prices fell to $40 per barrel, after hitting that $140 peak in 2008. The low cost of oil and gas ignited a big rebound in the equity markets that continues to this day.

It is my contention that if oil and gasoline prices stay at current levels, and/or if they go significantly higher from here, it could be the catalyst for a big pullback in the economy and the stock market.

So far, stocks essentially have ignored higher oil and gasoline prices. That resilience clearly can be seen by the bullish chart pattern (see above) of the S&P 500 Index. But how long can this avoidance of reality last?

The answer to this question remains open; however, experience tells us that those who cannot remember the past are condemned to repeat it.

A Chinese Headwind

One headwind of more immediate concern to this market than even oil prices is the economic slowdown in China. In recent days, investors have turned sour on Chinese stocks. The chief reason why is the slowdown in the growth rate of the world’s second-largest economy.

Recently, the Chinese government lowered its full-year 2012 gross domestic product (GDP) growth target from 8% to 7.5%. That slowdown is substantial, especially given the size and influence the Chinese economy has on the rest of the global economy. However, the story involves more than just a slowdown in China’s rate of growth.

We just received the news that Chinese auto sales this year will probably miss their 8% growth forecast as the slowing economy and rising fuel costs curb buying. Auto sales are a big canary in the coal mine for an economy, and a slowdown is a bad omen for Chinese GDP growth.

Perhaps even worse than the auto-sales slowdown is a fizzling Chinese real estate bubble. For the past five months, real estate values have been falling sharply, and there doesn’t seem to be much that Beijing’s policymakers can do to staunch the bleeding. Much like our own real estate bubble in the United States, there was too much inventory build out during the boom days. As we all know, that situation corrects itself in a very painful manner.

The effect of the recent downbeat news inChinahas been a sell-off in stocks tied to the country’s fortunes. The chart here of the iShares FTSE China 25 Index (FXI), which tracks China’s large-cap stocks, shows the fund’s share price breaking down below its 50- and 200-day moving averages.

One more thing that is troubling about China is a growing chorus of calls that the country already may be immersed in a so-called “hard landing.” The latest, and perhaps most significant, hard-landing call comes from Adrian Mowat, JPMorgan Chase & Co.’s chief Asian and emerging-market strategist.

During a conference in Singapore last week, the respected Mowat said the issue of a hard landing in China now is beyond debate. “If you look at the Chinese data, you should stop debating about a hard landing,” said Mowat, who added, “Car sales are down, cement production is down, steel production is down, construction stocks are down. It’s not a debate anymore, it’s a fact.”

If this assessment is true, then China’s hard landing represents a big headwind, not only for stocks in the region, but for stocks here at home — as well as the fortunes of the global economy.

Baby Wisdom

“A baby is God’s opinion that life should go on.”

–Carl Sandburg

Helping investors create a life free from financial worry is what my family and I have been dedicated to for the past 35 years. And with every new generation, it’s what we will remain committed to. Here’s to the newborns, the veterans, and everyone in between. May your journey be a self-made masterpiece of deliberate achievement.

Wisdom about money, investing and life can be found anywhere. If you have a good quote you’d like me to share with your fellow Alert readers, send it to me, along with any comments, questions and suggestions you have about my audio podcast, newsletters, seminars or anything else.

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