Rosenberg: Volatility, Oil Price Pressure Ahead

[Stocks-to-Watch]

After yesterday’s big drop, markets are just modestly lower today, as investors still try to get a handle on oil prices and its affect on the global economy.

Yet Gluskin Sheff chief economist Dave Rosenberg expects the ride to continue to be bumpy, with oil prices cramping growth and the potential for continued volatility throughout 2011.

“We have pretty well reached $100 per barrel on WTI and Brent is already north of that threshold,” he wrote in a research note out today. ” The two-year change in the oil price does sharply raise recession odds, and it is no surprise that nobody is talking about that prospect since nobody was talking about it in 2007 or 2008 either when we were already in one (though we are seeing some analysts say they draw the line at $120/bbl)…Because oil demand is relatively inelastic over the near-term, this price shock is going to cut into real global economic growth and the question is by how much – effecting discretionary consumer spending and profit margins, which we already see being squeezed in many of the manufacturing diffusion indices on pricing and revenues.”

Unlike in the past, Rosenberg notes, governments are not in the position to soften the blow from high oil prices either.

The next few months are also filled with events that could promote further volatility, he writes, from Irish elections on Friday (and the specter of default) to the March 4 deadline for a U.S. government shut down if political leaders cannot come to an agreement on spending. Further out, the Fed’s QE2 program ends in June, followed by the new fiscal year for U.S. state and local governments in July, when the real impact of spending cuts and tax increases will be felt without federal funding acting as a cushion, as it did last year in some cases.

Add to this increasing oil prices–represents about one-quarter of the U.S. consumer spending bucket and closer to half in many emerging market economies–and Rosenberg sees potential trouble ahead.* He concludes:

“Every time we have seen oil prices rise 120% over a two-year period there has been a recession, except in 2006 when the boom in bank credit and home prices provided a complete antidote. With complacency running at such a high level, surprises now, by definition, can only be in one direction.

“Also pay attention to what the bond market is telling you. Following a big spasm in the summer of 2007, we had a big rally that foretold something nasty was about to happen to the U.S. economy (a recession). Then again, after a spurt to 4% last April, much the same — a rally that correctly predicted the air pocket we saw in the economic data right through the spring and summer. And it has happened yet again except this time around the yield on the U.S. 10-year Treasury note got stopped out somewhere near the 3.8% threshold before the realization began to set in that the economic backdrop may be just a tad more fragile than what has been commonly perceived for the past six months.”



Original Article Source by Barrons.com