(Note: The author of this fundamental analysis is a financial writer and portfolio manager.)
Rising oil prices and a surging dollar could be a potential drag on U.S. equity prices, or at the very least slow down the stock market’s current rise. That is because increasing oil would be an added expense for businesses and their operations, while a rising dollar would make U.S. products sold abroad more competitive. Rising cost and declining revenue would ultimately pressure margins, and therefore cause earnings to see a slowdown or even potentially a decline. (For more, see also: How the Oil and Gas Industry Works.)
Climbing oil prices would help to bring on inflation, which could make the Federal Reserve more aggressive in raising interest rates, causing the dollar to appreciate versus foreign currencies. Oil prices are up by roughly 7% year to date, but up nearly 25% since bottoming at the end of the second quarter.
Oil has already broken out, as previously noted in an Investopedia article on November 9. The commodity surpassed a technical resistance level around $54, which helped it to rise to its current price of roughly $57. The next level of resistance to oil comes at $62, where a further rise could prove to be very damaging to the current state of inflation.
Oil and Inflation
Oil prices are closely correlated to the Producer Price index (PPI), an essential reading on inflation, and rising oil could help to push the PPI reading higher in coming months. The chart below shows how closely the PPI and oil have tracked one another over the past five-years if oil should continue to rise it will drag inflation higher along with it. (For more, see also: Why Oil May Plunge to $30 a Barrel.)
Rising Interest Rates
Rising inflation would likely cause interest rates on the long-end of the yield curve to begin to increase as well, as investors would grow more fearful of longer-term inflation. Rising inflation would also cause the Fed to become more aggressive, and raise interest rates at a faster pace and higher than currently expected.
A Rising Dollar
Interest rates that are rising would help to fuel a further rise in the dollar. Since bottoming in September, the Dollar index, a measure of the dollar versus a basket of foreign currencies, has risen from roughly 91 to 94.5, a rise of nearly 4%. Should inflation and higher rates take hold, the index could rise to a level of nearly 102, an increase of almost 7.5% from current levels.
Oil has already broken out, and how much further it will rise is likely to trigger a chain of reactions.
Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company’s actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer’s bio and his portfolio’s holdings. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.