Markets Have No Memory Whatsoever

I was somewhat surprised by the markets' strength yesterday. And so far today, the market is down. The market has no memory from day to day whatsoever. How does one begin to make sense of these gyrations?

Because we are coming to the end of the month and end of the quarter, and because of the various cross currents of high energy prices and Katrina, I am simply staying on the sidelines. I remain cautious in my outlook, though not pessimistic.

A strong part of my cautious outlook is that I think people are underestimating the effects of high energy prices. While we have not seen any strong negative effects, I am not confident that we will escape them.

In yesterday's Wall Street Journal, Bhushan Bahree wrote a Page One article Why Oil's Surge Hasn't Damped Global Growth (subscription required).

"The cost of continuing economic growth will be rising oil prices," says Philip Verleger Jr., an oil economist and senior fellow at the Institute for International Economics in Washington. Oil prices may well rise to $100 a barrel, but that alone wouldn't trigger a recession, Mr. Verleger says. The rise in oil prices "ends when the global real-estate bubble bursts."

While crude oil-prices recorded another record in nominal terms last night, the record in inflation-adjusted terms would be over $90 in April 1980. Energy futures spiked Sunday evening, as traders got a chance to react to the new and dire course charted by Hurricane Katrina. In overnight electronic trading on the New York Mercantile Exchange, October crude-oil futures opened up more than $4 from Friday's close of $66.13, topping $70 a barrel for the first time.

I will take the other side of the argument of Verleger Jr. At $100 or more, economies around the world will definitely feel the effects. How can I be so sure? Go to the BP Statistical Review, and download the Microsoft Excel™ workbook and look at the tab Oil Consumption — barrels. Toward very bottom of the tab we see that the total world consumption in 2004 was roughly 80.8 million barrels per day. Of that, 3.8 million barrels were consumed by Former Soviet Union countries and another 28.2 million barrels were consumed by Emerging Market Economies. So about 30 million barrels of approximately 80 million barrels were consumed by the poorer nations of the world. I doubt strongly that these economies can withstand $100 per barrel oil prices without suffering strong negative effects. Emerging markets tend to be manufacturing and agricultural product focused—both of which are heavy users of energy. If a substantial portion of the emerging markets suffer, even us in the developed economies will feel some effects.

Moreover, Europe is not bubbling with economic strength either. An additional burden of $100 per barrel oil price certainly would not help.

When you put together the negative effects from emerging markets and from some European countries, I believe the world economy would slow at $100 per barrel oil price. I just hope we do not get to that price level where we will learn who is right and who is wrong.