Sunday, December 10, 2006

High Energy Prices and Weak Housing Will Finally Take Toll on Economy

Energy prices and the health of the housing market are perhaps two of the most important factors affecting our economy today. Stocks have rallied in recent months largely due to optimistic outlooks for both of these factors. My outlook is much more pessimistic.

Oil prices peaked around $78 per barrel in late summer. Investors cheered as prices came back down. But I've been pointing out that prices are still very high. Even at $40 to $50 per barrel, they would be much higher than they were just a few short years ago. These days they are hovering above $60 and OPEC seems to be getting serious about cutting production.

OPEC has learned a very valuable lesson. Oil producing nations like to get as high a price as possible, but OPEC was always worried that if prices went too high, economies might go into recession causing demand for oil to plummet. The lesson they learned is that most economies could easily sustain $40, $50, even $60 per barrel. OPEC's target range for oil prices used to be about $25 to $30 per barrel. Today, $60 is the new $30. Now OPEC fears falling prices more than rising prices. It seems to be getting serious about cutting production to keep prices around $60. That is not good news for the U.S. economy.

Housing is also a major problem. Most economists were betting on a soft landing in the housing market. Right now, it looks like the landing may be fairly rough. Inventories are high, prices are falling, cancellation rates are rising, foreclosures are up, and the sub-prime mortgage market is seeing rising defaults.

This double whammy of high energy prices and a collapsing housing market means GDP growth in 2007 will likely be less than 2%.