JEFFREY BROWN: The bleak news came on two fronts. A big drop on Wall Street brought the Dow to its lowest point since September 2006, and a sharp rise in oil prices, moving into record territory yet again.
For a look at what’s going on, we turn to Hugh Johnson, chief investment officer for First Albany Corporation.
Well, Mr. Johnson, it’s been a terrible few weeks on the market. Was there something special driving it further down today?
HUGH JOHNSON, chief investment officer, Johnson Illington Advisors: I don’t think there’s anything special, Jeff. I think it’s really more of the same. As investors, we’re really reminded of the fact that there are significant risks or real problems for the U.S. economy.
We started the day, when Goldman Sachs, which is a highly regarded investment firm, said that Citigroup, Merrill Lynch have some substantial write-offs ahead. In other words, bad credit conditions are going to continue to plague big financial institutions and, therefore, their ability to land and drive the economy.
Obviously, second, as you mentioned, the price of oil going up to a new record, that raises real problems, an oil tax for the economy, which is going to be extraordinarily difficult for the economy to absorb and continue to expand.
And then yesterday, of course, the Federal Reserve told us that they’re worried about inflation and they may raise interest rates.
So there are these headwinds that are facing investors. One we could manage, but, quite frankly, collectively investors have said this is too much for the economy and earnings in the second half of this year. It’s going to be tough for this economy to make any headway.
Price of oil destroys winter gains
JEFFREY BROWN: And yet, it's not that long ago where things were starting to look up. It looked as though maybe the Fed had brought the housing and credit crisis under control. What happened?
HUGH JOHNSON: It did. It looked that way in the middle of March when they assisted in the rescue of Bear Stearns and did some very creative things. I agree that, and the markets started to perform well or send a message that things were going to be better for the economy and earnings in the second half.
But since then, a lot of things have happened. But the most important that's happened, of course, is the price of oil has spiked higher. I think it's driven primarily by speculators.
It does not reflect supply-and-demand conditions in the U.S., but, nevertheless, it's at a very high price. Obviously, prices at the pump are high. And as you might expect, in response to that, consumer confidence has deteriorated.
So, basically, investors have said, with this additional risk, and now with the Federal Reserve saying they may raise interest rates, that's just too tough for the economy to overcome. In other words, the economy is not going to recover in the second half of this year, as we previously had thought would happen.
JEFFREY BROWN: Well, let's look at oil prices specifically, and again today, another big jump. Did something happen today to cause that jump?
HUGH JOHNSON: Yes. There were really a couple of things. First of all, Libya, which is a big producer of oil, an exporter of oil, said that they were going to possibly -- said that they were going to reduce production. That was disturbing to the market.
But I think what really disturbed the market the most was the president of OPEC, the Organization of Petroleum Exporting Countries, said that he thought that the price of oil per barrel could go to $150 to $170 per barrel.
And when you get to that level, Jeff, you're talking about a price at the pump that could be something close to $5 per barrel. You just can imagine what that's going to do for consumer spending. Consumers will simply have to cut back. And, you know, consumer spending is 70 percent of our economy.
So, again, that tax, that oil tax, that tax on the U.S. economy, if you got to that level, would be very, very significant and make it very difficult to make the case that the economy's going to continue to expand in the second half.
Wall Street and the Fed worried
JEFFREY BROWN: But explain something to me, because this is not the first time that an influential person predicts that the price is going to go up. The same day he predicts the price is going to go up, what happens? Investors step in and bid the price up.
It sounds, sitting here, like circular reasoning. I mean, was there something fundamental in the price of oil today? Or is this the way the market is working right now?
HUGH JOHNSON: This doesn't reflect fundamentals, in my judgment. It reflects the fact that it's perceived to be the case that the president of OPEC sort of has his hands on the levers or at least knows something that perhaps other investors don't know.
So the perception is that he knows something; the price of oil's going to go up; therefore, the outlook for the economy is going to deteriorate.
You know, on Wall Street, investors, the way they operate is very psychological. And if somebody of influence, somebody in a position that's supposed to know what's going on, says something, investors collectively respond to that.
Wall Street is constantly responding to news, even though it may not be valid. So you're absolutely right.
JEFFREY BROWN: And, briefly, Hugh, you said -- you mentioned the Fed not acting yesterday, but signaling that, when it next does act, it might go up, raise rates.
HUGH JOHNSON: That's absolutely right. They said that they're worried about inflation, obviously, inflation that's driven by rising oil prices, in part, rising commodity prices. We've seen the price of corn, lots of other things starting to go up.
I think everybody you talk to on the street says, boy, I'm starting to see a little bit higher prices. In other words, inflation is starting to become a real problem. And the Fed said, "We don't want that. We can't let inflation start to take hold. We can't let inflation expectations in the economy start to worsen."
So they simply said that they're preparing us that, if the economy should allow it, if we got a strong enough economy, they'll raise short-term interest rates. The consensus now is they might raise interest rates in September.
I'm not sure whether they will or they won't, but if economic conditions are a little bit stronger, they probably will.
JEFFREY BROWN: All right, Hugh Johnson. As they say, don't shoot the messenger, so I'll just say thank you for joining us.
HUGH JOHNSON: My pleasure.