Wall Street adjusts for rising oil prices
TAKE a quart of high-priced Saudi Arabian oil. Toss in 150 yen for every American greenback. Fold gently into the stock market. Bake in the summer sun until done. The result is a Wall Street financial goulash of oil, currencies, and stocks. How it tastes depends on where you sit.
Last week, petroleum prices popped past $21 a barrel in the wake of an Iranian gunboat attack on a supertanker plying the Persian Gulf for Texaco.
The attack was considered a warning of sorts. Later this month, the United States plans to reflag and escort Kuwaiti tankers. Oil traders are worrying this may escalate hostilities. Further attacks on tankers could halt or at least stem the flow of oil out of the gulf.
The economic consequences may be fodder for investors. Indeed, John D. Connolly likes his market goulash spiced with such Persian Gulf uncertainty. The bearish Dean Witter Reynolds investment strategist has been profiting from an overweighted position in energy stocks. But it isn't solely Persian Gulf tension that has him wading into the oil issues.
His strategy springs from last month's Organization of Petroleum Exporting Countries' agreement of only moderate production hikes.
``OPEC is back in control,'' he says. ``It's only a matter of time before we see higher energy prices.''
Mr. Connolly says the oil price plunge to single digits last year gave OPEC members a bitter taste of the financial implications of disunity. Wall Street is noting the cartel's new commitment.
``When they established the $18-per-barrel target in December, the market was extraordinarily skeptical,'' he says. ``The market tested the target, and it held up. In June, OPEC translated the target into a floor. I think people are becoming convinced $18 is the floor.''
If Connolly is right that oil prices are headed higher - an inflationary development - then non-oil stocks could diminish in value.
Ronald Londe, a petroleum analyst with A.G. Edwards, doubts crude prices are heading higher. He agrees $18 is probably the base price. And he allows that Gulf flare-ups may trigger some additional buying. But within the next month or so, supply and demand factors will probably drag prices back to earth.
Mr. Londe notes that Saudi Arabia and OPEC exceeded quotas in May and June. ``That oil will hit the market at the end of July,'' he figures. Summer travel demand tends to peak about the same time, and currently there's plenty of gasoline and jet fuel supplies. Also, Iraq will be bringing a new pipeline on line in late August. ``Traders will soon be looking at these things,'' he warns.
With crude selling at the highest levels in 18 months, Londe rates most oil company stocks as holds or sells. ``These stocks are not cheap by any stretch of the imagination. I think an investor getting in at this point is taking a lot of risk.''
He notes that a year ago crude issues sold at a 42 percent discount to appraised value. Now they're selling at 1 to 2 percent above appraised value. ``It's very rare for oil stocks to sell above appraised value,'' he says.
The appraised value of the Dow Jones industrials continued to rise last week. Takeover rumors, decent second-quarter earnings, and diminishing inflation concerns produced heavy trading volume and new highs on the Dow Jones industrial average. It closed Friday at 2,455.99, up 26.46 points in five sessions.
The US markets are also benefiting from the return of foreign buyers as the dollar has quietly risen and firmed.
Instrumental to the dollar's resurgence, says Connolly at Dean Witter, is a change in currency-trader attitudes. ``Until recently, traders thought they were bigger than the central banks.'' But the banks have spent vast amounts over the last four months to prop up the dollar.
``Traders,'' he says, ``are now persuaded of the central banks' plan to keep the dollar around 150 yen.''
But both traders and the Federal Reserve will be watching the trade deficit figures closely. Two months of improvement have encouraged believers in the long-awaited J-curve. The key question now is whether the dollar at 150 yen is low enough to continue the trend.
Last week, US Trade Representative Clayton Yeutter said US exports were competitive at these exchange rates and that US exports to Japan would not slacken.
Connolly has his doubts. He notes that the dollar was at almost the same level a year ago, and the trade deficit didn't improve. ``If we begin to see trade numbers that are not particularly encouraging, then you may see a softer dollar approach'' from Alan Greenspan, who succeeds Paul Volcker as Fed chairman on Aug. 6.