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Wednesday, March 28, 2007

March 28 2007 - The Short View By John Authers

March 28 2007 - The Short View By John Authers
Copyright The Financial Times Limited 2007
Published: March 28 2007 03:00 | Last updated: March 28 2007 03:00
As 2007 dawned, Iran was the greatest worry on investors' minds. The one most alarming geopolitical risk that could upset all bullish scenarios was an extension of the Iraq conflict to its bigger neighbour, with all its implications for oil supply and for the balance of power in the rest of the Middle East.

So why has the crisis over the UK hostages held by Iran (to the backdrop of speculation that Israel is readying a strike against Iran) been accompanied by a recovery in stock markets, and a return of risk appetite?

The easiest answer is that the attention is currently elsewhere. The problems of the US housing market, and the related crisis for subprime mortgage lenders, dominate perceptions of risk.

Beyond that, the situation in Iran hashad an impact on the oil price. The price of West Texas Intermediate crude has risen 11 per cent over the past two weeks. With the "heating" season drawing to a close and the "driving" season still in the future, this is in large part down to events in Iran.

But the relationship between oil and stock prices is changing. Last year, after WTI crude touched $77 a barrel, there was a clear inverse relationship between the oil price and stock markets. The long equity rally over the latter half of the year started on almost the same day oil peaked and began a descent to bring it down by 35 per cent. Oil near $80 was so expensive that it threatened on its own to trigger a recession. A clear inverse relationship with the stock market thus made sense.

Over history, there has been no such inverse relationship. Demand for oil correlates with industrial activity, which in turn correlates with stock market performance. Even after its recent rise, WTI stands at $62.50 - disquieting on many levels, but not enough to spark a macroeconomic "event".

Further, energy stocks tend to benefit from a higher oil price. Since February 27, the day of the recent sell-off, the S&P 500 energy sector has gained 6.4 per cent, leading all sectors. It is only 2 per cent off the all-time high it set last December. So Iran has had an impact on the market - it appears in fact to be pushing stock indices up in the aggregate. Whether that can continue if the crisis deepens is another question.

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