Oil, Inflation, Interest Rates, and Uncertainty

The recent and relatively precipitous decrease in the price of oil is likely to lead to a period of adjustment and uncertainty.  Markets typically have not liked uncertainty.  This suggests that investors are likely to be subjected to increased market volatility until there is greater visibility relating to the economic and geopolitical impact of the significant change in the price of oil.

An expected increase in volatility based on heightened uncertainty, is not a reason to suddenly abandon carefully constructed long-term investment strategies.  When the pilot announces expected turbulence and asks passengers to fasten their seatbelts, he is not suggesting that now is the time to grab a parachute and jump out of the airplane.

While it is not possible to predict where the price of oil is going from here, if oil prices gradually stabilize at or near $50-60 per barrel, compared to the roughly $100 per barrel price of the last several years, there are going to be some big winners and big losers.

One area, which should be of interest to investors, is the potential for a longer than expected period of very low interest rates.  With the average price of gasoline near $2.50 per gallon, and heading south, current estimates for increases in the consumer price index, may be too high.  If this proves to be the case, the Federal Reserve Board may be less disposed to raising interest rates as early as some economists are expecting.

American consumers are likely to be among the big winners.  Not only have gasoline prices dropped significantly, but almost every thing we purchase has an energy cost component.  This is likely to be reflected in prices, although probably not as quickly or visibly as for gasoline and home heating oil.

Clearly, the big losers are the oil exporting countries, particularly those with national budgets based on $100 plus oil, some of whom have not been all that friendly to American interests.

All comments and suggestions are welcome.

Walter J. Kirchberger, CFA®