We were overdue for a correction, but last week's 1.7% drop in the S&P 500 was pretty tame by historical standards, and the S&P is still positive (up 5%) year-to-date. Tuesday's 2%-plus drop seemed scary, but it was on light volume, as Libyan unrest and soaring crude oil prices caused many investors to freeze, sparking a sharp sell-off. But Friday brought a solid recovery on higher volume, and we could see another sharp rise this Friday, after the next jobs report.
Market Overreacts to Libyan Unrest, Oil Prices
Last week, Wall Street was seemingly "looking for a reason to sell" after the President's Day weekend. Traders panicked on Tuesday, following Libyan leader Muammer Gaddafi's 75-minute hate-filled speech, in which he vowed to fight Libyan protestors (whom he called "rats") "to the death." Top oil executives feared that Libya's oil production (2% of global supply) was at risk, so they halted oil production there.
Adding to Wall Street's panic, Time magazine reported that Gaddafi was trying to sow chaos by ordering his security forces to start sabotaging oil facilities by blowing up oil pipelines and cutting off the oil flow to Mediterranean ports. Fortunately, no pipelines were blown up and only about half of Libya's production was shut down by the end of last week, but an epic battle for the city of Zawiyah, 30 miles from Tripoli, may be necessary, since Gaddafi's security forces have surrounded that city. Over the tense weekend, U.S. and European leaders imposed trade sanctions on Libya and called for a travel ban on the remaining members of Gaddafi's regime after security forces loyal to Gaddafi shot protesters in Tripoli.
In addition to these rising tensions in Libya, there were serious concerns that protests might spread to other major OPEC nations, including the dominant oil-producing power, Saudi Arabia. However, King Abdullah of Saudi Arabia is attempting to stem any unrest by announcing $36 billion in financial aid, including a 15% salary increase for public employees "to offset inflation," debt relief, and financial aid for students and the unemployed. Additionally, the Saudi government pledged to spend $400 billion by the end of 2014 to improve education, infrastructure and health care. Saudi Arabia also said that they will boost their crude oil production to make up for any shortfalls from the chaotic situation in Libya.
The International Energy Agency (IEA) reported Thursday that only 500,000 to 750,000 barrels of crude oil per day have been removed from the world market, less than 1% of global consumption. The IEA also said that it is in close contact with OPEC and that IEA members have 145 days of emergency oil supplies in inventory. In North America, we do not import oil from Libya and we remain awash in crude oil. In fact, the Department of Energy reported that crude oil inventories rose by 800,000 barrels in the latest week. That's why crude oil prices backed off their 30-month high Friday, after hitting $119 on frantic trading Thursday. Even though the Libyan situation is still unfolding and Gaddafi will likely be ousted within a week or two, it appears that crude oil traders grossly overreacted to the Libyan news.
Food Shortages Spawn More Protests
I expect crude oil prices to settle down in the upcoming weeks, but the world must still deal with the impact of higher food prices. Rising food prices originally sparked the protests in many poor countries in North Africa and the Middle East. Since high food prices impact the poor disproportionately, protests are spreading to a wider variety of nations. By viewing other revolts on TV or the Internet, the poor now feel empowered to demand political reform and greater access to food and other basic life necessities at home.
This trend is also true among the giant Asian economies in China and India. Food shortages in Northern China have led to renewed demands for access to food, while thousands of protestors descended on New Delhi, India on Wednesday to demand some relief from runaway food prices. Between them, China and India are home to nearly 40% of the world's population, so these giant economies bear close watching.
In America, the Department of Agriculture announced Thursday that the prices for corn, wheat and soybeans might surge further in the second half of 2011, due mostly to anticipated supply bottlenecks. Despite higher plantings for corn and soybeans this spring, the supply is expected to remain tight due to strong export demand and rising biofuel demand. Currently, the U.S. ethanol industry consumes 36% of the U.S. corn crop. Since the U.S. supplies 50% of the world's corn and 33% of the world's soybeans, one solution to the global food crisis would be to rethink pouring 36% of our corn crop into our gas tanks!