World Crises Can Lead To Stock Market Crash


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Alex Christensen of Global Risk Insights offers a warning to global investors dealing with the global turmoil and U.S. stock markets.  Developments in Ukraine and the Middle East can prove harmful to the U.S. stock market.  With the unfortunate Malaysian Airlines crash being a result of actions of Russian-tied rebel factions, there is increased pressure on the European Union to impose economic sanctions on Russia.  Even though the U.S. will likely press for crippling actions on the Kremlin, Europe had a lower appetite for this move because their economic prosperity is tied to access to plentiful Russian energy sources.  Now with this distasteful event, Europe will face more outward pressure to respond to their neighboring menace even if it contributes to a recession for them.

Then there are rising tensions in the Middle East where ISIS are gaining ground in Syria and Iraq, while Israel is expanding operations in rooting out Hamas in Gaza.  This is also spooking global investors that are concerned about about free flowing oil.  If access to oil is compromised by these developments, then that can dampen economic growth because businesses and consumers rely on crude oil to keep their energy prices low.  If crude oil becomes scarce, then that will drive up the cost of gasoline and causes both consumers and businesses to downsize.

Global investors are aware of the risks associated with Eastern Europe and the Middle East and have sent their funds to safe U.S. Treasury securities.  Even though Standard and Poor’s have reaffirmed the U.S. credit rating at AA+ due to high budget deficits and Congressional gridlock, they still remain a safe haven for investors seeking safety.  When investors start buying bonds, this drives down their yields and thus bring down other interest rates associated with it, such as the prime interest rate and the mortgage rate.

With interest rates remaining low, there is enhanced risk of asset bubbles. As implied by Christensen, the Fed has been trying to normalize interest rates, which have been artificially lowered by Fed policy aimed at boosting employment.  Even though the Fed actions have undoubtedly improved labor markets with U.S. unemployment rate on the decline, it has roiled foreign markets, who are struggling to tamp down inflation and prevent asset bubbles themselves.  Eventually, these same symptoms could be felt in the U.S., especially if signs of a more robust recovery becomes more consistent.  Stronger labor markets will provide U.S. consumers with more security and income, thus resulting in more savings.  If U.S. consumers decide to shift their increased savings to the U.S. stock market, then there is concerned that this could push equity prices to unsustainable levels and cause a market crash.

All of these events can compromise Fed policy and end up swallowing wealth in the long-run.

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Why Are Gas Prices Rising?


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You might have noticed a spike in gas prices over the last couple of weeks.  Neil Shah of Wall Street Journal’s Real Time Economics reports that crude oil prices are at a 52-week high.  Specifically, crude oil prices have risen to $108.05 a barrel.  When looking at the market for gasoline, the price of gas is affected by the market forces of supply and demand.

Neil Shah mentions two factors:  a rise in crude oil prices and an improving economy.  Crude oil prices affects supply, while a stronger economy boosts demand.

There are four factors that affect supply.

  1. Change in input prices (any process or resource that goes into making a good)
  2. Change in technology
  3. Change in the number of sellers
  4. Change in the expectations of sellers

In this case, we want to focus on input prices.  Regarding inputs to providing gasoline, think about labor, land, and capital.  In this case, crude oil is considered land, which refers to any natural resource.  Without crude oil, it is impossible to produce retail gasoline.  Crude oil is accessed by refineries, who are then able to convert it into retail gasoline used by cars.

There are five factors that impact demand.

  1. Change in taste (activity is more or less attractive)
  2. Change in income 
  3. Change in the price of related goods
  4. Change in number of buyers
  5. Change in the expectations of buyers

When Shah stated that greater economic optimism is causing prices to rise, this relates to the first and second factors of demand.  When an economy is improving, that means incomes are rising and consumers are more likely to drive and travel because they have more money to spend on shopping.  Even though the unemployment rate remain elevated, consumer spending has been trending up.

It was a little confusing when Shah referred to a boom in American oil production.  That typically results in an increase in supply and drives prices down.  However, that would explain previous dips in prices.  What is happening now is that the utilization of refineries are near full capacity at 90.7% as of the week ending on June 28.  In fact, U.S. refineries are operating at the highest level since 2007.  That indicates that driving activity is on the rise and that would place upward movement on prices due to the first factor of demand again.  If the utilization of refineries start to fall due to refineries expanding capacity through improved technology, then that would be an example of an increase in supply that would drive prices down due to the second factor.

Speculation also plays a role in gas prices and we can look to uncertainty with Egypt.  Even though Egypt is not a major source of our gasoline supply, political turmoil there could impact global supply.  This scenario would be consistent with the first factor dealing with supply.  In this case, prices are driven up not by current market forces of demand and supply, but potential future disruptions in oil supply if the Middle East experiences more political instability.  If disruptions are severe enough, then that would drive the price of crude oil up, which is an example of an input price.

When wondering why gas prices change, one can often look to the market forces of supply and demand.  However, we must also realize the role of market speculation in influencing gas price movements.