Plunging Oil Prices Drag Down Stock Market

by John M. Curtis
(310) 204-8700

Copyright May 11, 2011
All Rights Reserved.                                         

                 Showing the harmful effect of commodity prices on the stock market, the Dow Jones Industrials and tech-rich Nasdaq nosedived today from plunging oil prices.  Commodity prices—especially crude oil—have been escalating for months, threatening to hit new highs from the July 8, 2008 all-time peak of $147 a barrel.  Proving that economics is not rocket science, stock prices should have rallied, not plummeted, that oil prices were finally returning back to earth.  Since the markets don’t follow logic, plunging oil prices rattled unregulated hedge and private equity funds, fearing a drop in crude oil was related to the economy heading back into recession.  Only one small problem:  The economy added 268,000 private-sector jobs in April, signaling that unemployment—a lagging economic indicator—is finally improving, pointing to an undeniable upturn in the economy.

            Plunging oil prices should be welcomed news to consumers, whose wallets were emptied because of high pump prices.  Oil companies have been relentless keeping pump prices high during the latest slow growth period.  Because over two-thirds of the nation’s Grosss Domestic Product is built on consumer spending, plunging crude oil prices should benefit corporate earnings.  Runaway trading by mutual, hedge and private equity funds caused the latest sell-off, demonstrating the damaging effect of unregulated trading in gasoline and crude-oil futures.  While things can change overnight, hour-to-hour or minute-to-minute, crude oil prices appear to have peaked, meaning that the funds take profits and keep cash on the sidelines.  If recent history is any guide, crude oil will perk back up once the profit-taking ends.  Gone are the days when legitimate supply-and-demand drove crude oil prices.

            Today’s news by the Energy Information Bureau that consumers spend less on gasoline stunned oil markets causing the latest sell-off.  When oil or gas prices drop, it’s usually because the oil industry has  priced oil to the breaking point.   With unleaded regular averaging nationwide about $4 a gallon, consumers have tightened belts and reduced discretionary spending.  Today’s sell-off in crude oil has to do with profit-taking at major funds after a 50% rise in prices over the last six months.  When you have the New York Mercantile Exchange and major funds trading in crude oil futures, it’s difficult to stop runaway prices.  Short selling by hedge and private equity funds could take crude oil prices down even further.  Plunging crude oil prices have little to do with expectations about lowered demand.  By conserving more, today’s consumers are simply telling the oil industry to drop prices.

            When President Barack Obmaa signed the financial reform bill into law July 20, 2010, he didn’t make changes to the currently unregulated hedge and private equity funds.  Hedge and private equity funds operate outside the control of the Securities and Exchange Commission, giving them more latitude for short selling.  With today’s stunning conviction of billionaire hedge fund manager Raj Rajaratnam for insider trading and securities fraud, there’s some hope that Federal Reserve Board Chairman Ben S. Bernanke, Treasury Secretary Tim Geithner and key members of Congress will seek regulation of the hedge fund industry.  Long-term economic growth depends on a growing stock market, something prevented by short selling in unregulated private equity funds.  It’s difficult to give small investors long-term growth when private equity and hedge funds short the market.

            Whatever loose ends existed in last year’s financial reform, Obama must do a better job of preventing history from repeating itself.  There’s nothing in the July 20. 2010 financial reform bill that prevented hedge and private equity funds from short selling commodities and financial stocks.  Heavy short selling in 2007 of financial stocks resulted in the nation’s biggest financial institutions losing trillions in liquidity and market capitalization.  Short selling oil futures threatens long-term investors hoping that commodities, like crude oil, were the right choices for their portfolios.  Some responsible regulation of commodity or financials short selling should help stabilize long-term market growth.  Long-term investors and publicly traded companies can’t be held hostage by unregulated short selling  Financial reform must deal with unregulated commodity trading and short selling.

              Today’s sell-off in oil future was long overdue, considering the punishing pump prices that encourage the wrong kind of conservation.  While there’s nothing wrong with more fuel efficiency standards, there’s something very wrong with oil companies pushing pump prices beyond the reach of ordinary consumers.  Transportation companies also can’t thrive when the nation’s biggest funds push commodity prices to the breaking point.  Plunging oil and pump prices should have a stimulus effect on the stock market by giving individuals more cash for consumer spending and improving profit-margins to private and public companies.  When the market digests the advantage to the economy of lower pump prices, gas and oil prices should rebound.  It won’t take too long for commodities to sell-off, opening a new round of price hikes.  Some regulation of commodity and financial products is in order.

John M. Curtis writes politically neutral commentary analyzing spin in national and global news.  He's editor of OnlineColumnist.com.and author of Dodging the Bullet and Operation Charisma.

©1999-2005 Discobolos Consulting Services, Inc.
(310) 204-8300
All Rights Reserved.