Oil Surge to Weigh on Stocks, Consumer Spending

NEW YORK (TheStreet) -- The month of July has already seen a surge in oil prices, with markets trading above $102 per barrel. This is the highest level in more than a year, driven largely by conflicts in Egypt, signs of rising summer demand in the U.S., and by falling supply stockpiles. Since June 24, oil has gained nearly $10, and, at this stage, it is important to consider the potential effects this rally will have on consumer spending, stock values and the economy as a whole. Ultimately, with oil trading at its current levels, this year's rally in stocks meets another point of vulnerability.

Egypt Conflicts

Conflicts in Egypt are creating dual negatives for the market: adding an element of general uncertainty and raising concerns over oil supply disruptions for exports travelling through the Suez Canal. This will continue, at least for the short term, as the ultimate effects of President Mohammed Morsi's resignation ripple through the market.

So, while these events have done little to directly impact the global economy, their effects on sentiment and risk-aversion are clear. Egypt is not an oil producing country -- but it does control the Suez Canal, and as long as oil remains above the psychological $100 level, stocks will face headwinds as well. Roughly 2.5 million barrels of oil are sent through the Suez Canal (using the SUMED pipeline) each day, so political and military conflicts in these areas have the tendency to create additional volatility in energy markets.

On the positive side, the recent unrest in Egypt has failed to move markets as much as the "Arab Spring" of 2011, where massive street demonstrations and political turmoil propelled oil much more forcefully toward new long term highs. Similar events this year have not jarred the market as much, as these events are less surprising and the probability of supply disruptions is more predictable. But if oil prices remain elevated, the broader effects on consumer spending will become clear, weighing on consumer purchases of goods and services (which make up about 70% of the economy).

Bullish Inventory Data

At the same time, bullish inventory data is seen as supportive for near term oil prospects, with this week's crude supplies falling by 10.3 million barrels (2.6%), to 383.8 million barrels. These declines come as the result of temporary pipeline closures in Canada, and strong demand from BP's re-opened refinery in Indiana. Gasoline supplies were also lower (reversing analyst expectations for an increase). Viewed in conjunction, these figures in oil and gas inventories suggest that demand in rising in the U.S., and this another bullish element to consider when assigning market valuations.

The S&P 500 is trading back toward the middle of its monthly range, but additional upside looks unlikely as long as external uncertainty and elevated oil prices limit prospects for further runs higher. The key area to watch going forward will be gas prices, which so far have not rallied as much as oil and have the potential to negatively influence consumer spending. If a sluggish economy ultimately translates to weakening global demand, supply levels remain adequate, and concerns in the Middle East begin to subside, the rally in oil will fade as well.

But with prices still well below last year's resistance highs (at $110 per barrel), there is scope for additional upside in crude. Until we see a meaningful turnaround in prices, stocks will have difficulty gaining additional momentum. This makes it more likely we will see a spike back below 1600 in the S&P 500 before we see another test of the all-time highs.

At the time of publication the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Richard Cox is a university teacher in international trade and finance, focusing primarily on macroeconomics and price behavior in equity markets. His articles appear on a variety of websites, including MarketBulls.net, Seeking Alpha, FX Street, and others. Investing strategies are based on technical and fundamental analysis of all the major asset classes (stock indices, currencies, and commodities). Trade ideas are generally based on time horizons of one to six months.

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