Fisher Investments Editorial Staff

A Highly Speculative Bet on the Indirect

By, 02/28/2011

Story Highlights:

  • US GDP and consumer spending were revised slightly lower Friday, but both still grew.
  • Some fear higher gas prices resulting from Mideast unrest might dampen consumer spending.
  • While higher energy costs may not be money spent pleasantly, claims of this defeating economic growth are speculation.

Amid a busy news week dominated by unrest in Libya and resulting higher oil prices, the second estimate of US Q4 2010 GDP was released on Friday. The report showed a modest downward revision to headline growth from +3.2% to +2.8% annualized—though real final sales of domestic product (GDP less inventory change) still rose the most since 1998 (+6.7%). So what drove the downward revision? Largely three things. First, state and local governments cut spending by much more than initially estimated (less government spending is fine by us). Second, imports were revised up incrementally. And third, consumer spending was revised slightly lower from +4.4% to still-strong +4.1% growth.

Now, some fear recent contributions from consumer spending could be curtailed by rising oil prices (driven by Mideast unrest), increasing prices paid at the pump—thereby lowering GDP ahead. Possible. But it would require a far greater increase than what’s already occurred, and with Saudi Arabia announcing they’re prepared to step up production to mitigate troubled Libyan output, a sustained and sizable increase is far from certain.

Moreover, while energy might not be what folks enjoy spending on the most, gasoline purchases are still consumer spending. That spending might benefit non-US companies sometimes, but a global investor shouldn’t mind revenue irrespective of corporate citizenship. This increased spending on gas isn’t just money burned emitting gases, as some bemoan. It goes to drillers, refiners, distributors and marketers, the government, local gas station attendants, the folks engaged in drilling, their families (apologies to anyone we’ve omitted unintentionally)—constantly moving throughout a vast, interconnected global economy. And let’s consider the flipside of the high-oil, weak-spending argument: If it’s true oil prices have a direct, almost 1:1 impact on consumer spending, then shouldn’t consumer spending have risen when oil prices were low in Q1 and Q2 2009? Hint: It didn’t. And since then, as global economic growth has taken root, oil’s risen—and consumer spending is up. So oil’s impact on demand is not nearly as direct as many assume.

Now, it is true rising oil could increase transit costs for many types of goods. And contingent upon an industry’s pricing power, this can either buoy or detract from profits. But companies can also change what and how they ship or identify other ways to cut costs—which can mitigate oil’s impact. So determining how oil affects the economy isn’t as simple and neat as “rising oil prices are bad.”

Neither do we suggest ignoring them. Could sharply rising oil prices have an economic toll? Yes. But be careful about assumptions—oil prices rising and dampening growth is a frequently misunderstood possibility that could have an impact if pricing changes are unexpectedly large and sudden. Consider the current scenario: Assuming the certainty of gains big enough to have a major, lasting downstream impact on the prices of other goods is just a wild guess on the future behavior of an uncertain Libyan government, OPEC generally, non-OPEC production and export (America’s two largest oil suppliers, Canada and Mexico, are non-OPEC), domestic distribution of large existing supplies sitting in non-hostile Oklahoma, and myriad other economic factors beyond oil. At present, the assumption much higher oil prices are coming and will wipe out consumer’s wallets is speculation (of the highest order) on an indirect relationship between oil and consumer spending.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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