Like all of you I have been watching recent events in the Middle East with apprehension and horror and, like all of you, I am concerned about the effect this unrest will have on the budding economic recovery here in in the U.S. I will not comment on the social/political conditions that have brought the current situation in the Middle East to the unfortunate position that now exists. As the say in the military, that would be well above my pay grade. Nor do I know to how many other countries the unrest will spread. The socio-political conditions that are the underlying cause (extreme concentration of wealth in the hands of a few and a lack of economic opportunity for most) exist in a great many OPEC countries. I do, however, have to think about how to counsel our clients on what they should be doing from an investment perspective in response to the resulting turmoil in the financial markets.
At this point I do not expect that the temporary loss of Libyan oil production will seriously impact world oil reserves. Saudi Arabia has already indicated that they will increase production to make up for the relatively small drop. I do, however, expect continued upward pressure on oil prices. World oil demand has now recovered to pre-recession levels. Prior to the “great recession” oil was selling for over $100 a barrel and spiked as high as $140. This was primarily due to supply-demand factors. If demand has returned to pre-recession levels, then shouldn’t the price also return to pre-recession levels?
Most of the economists whose opinions I’ve read over the past month or so do not believe that oil at $100 will cause a spike in inflation, primarily because food and energy constitute a relatively small portion of household spending in the U.S. (about 14%). Housing and wages have much more of an impact on inflation. Frankly it’s difficult to envision upward pressure on either of these inputs. Housing prices are still declining and most probably will continue to do so for some time. In addition it’s difficult for labor to demand higher wages with the unemployment rate at 9.5%. As far as the recovery is concerned, the consensus in the economic community seems to indicate that oil could rise as high as $125 a barrel before the modest GDP growth predicted for the next few years is jeopardized.
For these reasons, the turmoil in the Middle East, while a humanitarian, political, and moral crisis, is not yet an economic one, despite the financial news media’s attempt to depict it as one. However, should the unrest spread to a major oil producer such as Saudi Arabia, I would be forced to reconsider. Our advice to investors is to review your investment strategy and your asset allocation and be sure that it is appropriate for your risk tolerance and financial situation. Next review your portfolios and be sure that you are adequately diversified. Stick to your plan and have courage and patience, both hallmarks of great investors. Oh, and if you’ve been sitting on cash remember that crisis brings opportunity.