Central bankers, politicians, company management teams and the public continue to fret about the cost of oil.

A high oil price is in effect a tax, as it increases costs and squeezes margins and cash flow at companies. It also crimps consumers’ disposable income and their ability to spend.

An oil price of $147 a barrel may not have caused the recession of 2007-09 but it may have tipped a fragile, indebted global economy – and febrile, over-leveraged financial markets – over the edge.

The oil price shocks of 1973 and 1979 did a lot of damage too, as they stoked inflation and pushed the US toward an economic downturn.

Oil had nothing to do with the US downturn of 2001 as that was an investment bust in the wake of the technology, media and telecoms bubble. But it seems reasonable to ask the question whether oil is again about to wreak havoc and prompt a recession, or at least stagflation.

Losing steam

There is some evidence of a slowdown in the world’s largest economy, the US. Where the US goes it is fair to assume the rest of the West will follow.

The new orders reading from the latest US purchasing managers’ index for manufacturing slumped by 7.9 points to just 53.8. That was
the biggest drop since April 2020 and if that reading goes below 50 then there could be trouble ahead.

This could be the result of supply chain friction rather than weak end demand, so it may not pay to jump to conclusions. But the Dow Jones Transportation index has slumped in the past month, and it peaked last November. The Baltic Dry shipping index has also sprung a major leak.

Regular readers of this column will know of Richard Russell’s Dow Theory, and is assertion that the economy, and by extension the Dow Jones Industrials, cannot do well if the Transportation index is not doing well.

If the economy is strong and goods are selling, the stocks must be replenished and shipped. If the economy is weak and goods are not selling, then shelves do not have to filled, goods do not have to be manufactured and moved, and trucks, planes, trains and ships stay idle.

So far, the Dow Jones Industrials is doing its best to ignore the Transportation index’s loss of momentum, but this is a trend that requires careful attention.

Shining bright

One bright spot remains copper. The malleable, conductive, ductile metal has many uses in infrastructure, cars, electrical goods, construction and more that it is seen as a good guide to the health of the economy, and hence its nickname, Dr Copper. The good news is the commodity’s price remains strong, despite fears over China’s economy.

The economic picture is far from clear cut and, frankly, it if were then share prices would have priced it in and moved on by now.

The economy is not the stock market and vice-versa. If a recession does hit, the markets will at some stage decide the outlook is so bad that it can only get better and start to discount an upturn, long before the data show any signs of improvement.

There is also the potential for policy intervention. Central banks and governments have shown they have little or no appetite for a recession or austerity, or the risk of financial market turmoil spilling over into the real economy. In the past they have quickly cut interest rates or spent money.

The difference this time is that inflation is roaring, rates are already low and coffers relatively empty. Indeed, money supply growth is sagging in the US, even before the Fed really tightens policy, and that could be the biggest challenge of all, at least for financial markets.

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