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U.S. Market Overreacting to Oil


Investors in the U.S. stock market may be overestimating the impact of record oil prices, even though higher fuel costs have helped trigger the last five economic recessions, according to Anirvan Banerji, director of research at the Economic Cycle Research Institute.

''People don't understand that how potent an oil shock can be is dependent on the stage of the business cycle,'' Banerji, 49, said in an interview from New York on April 22. ``It all depends on what the economy was predisposed to do in the first place,'' and ``at this point, the aircraft of the economy is poised to power up.''

Banerji declined to give a specific forecast for benchmark U.S. stock indexes, saying that markets are often wrong regarding the economic cycle. In April and May 2001 stocks rallied amid
hopes for a second-half economic rebound even though an economic recession had started in March, he said.

Concerns about energy prices and the pace of economic growth have weighed on stocks this year. The Standard & Poor's 500 Index has lost 4.9 percent in 2005 through April 22, while the Dow Jones Industrial Average has declined 5.8 percent. The Nasdaq Composite Index has slumped 11 percent.

Oil Rebound

Crude oil for June delivery climbed 6.4 percent to $55.39 a barrel in New York last week, its biggest rally in three months.

Prices are up 51 percent from a year ago and reached a record $58.28 a barrel on April 4...

The S&P 500 will climb just 3.1 percent in 2005, held back partly by higher oil prices, according to the median estimate in a poll of 14 analysts by Bloomberg in December.

Banerji has researched the business cycle for two decades, and cites Geoffrey Moore as his mentor. Moore, an economist who taught Alan Greenspan at New York University and developed the original index of leading economic indicators for the U.S. government, started ECRI in 1995 with colleagues such as Banerji who had been working at the Columbia University-affiliated Center for International Business Cycle Research.

2004 Call

New York-based ECRI develops and tracks custom economic indicators, such as the U.S. Weekly Leading Index, that use a mix of private and government data and market prices to anticipate the beginnings and endings of broad economic cycles.

The institute looked at factors...to correctly predict in March of last year that the pace of economic growth would slow by the end of 2004. They also said in March 2001 that a recession could not be avoided on the basis of their indicators.

Some investors have shrugged off higher energy prices because the economy is now less oil intensive and prices are lower in inflation-weighted terms than during previous surges in the 1970's and early 1980's. Banerji says this reasoning is insufficient to explain why the current level of oil prices will not have more of an impact. Rather, what is different this time is that the economy is on stronger footing, he said.

Gross domestic product probably rose at a 3.5 percent annual rate from January through March, according to the median estimate of economists in a Bloomberg News survey ahead of an April 28 report from the Commerce Department. In the prior three months, the economy grew at a 3.8 percent pace.

Still, the projected first-quarter growth rate compares with an average quarterly gain of 3.2 percent over the past two decades.

Not a 'Non-Issue'

"Don't let anyone tell you that oil is a non-issue, because how do you explain 2000-2001 then?'' he said, referring to a climb in oil prices to over $37 a barrel in September 2000 that helped push the economy into recession the next year.

Worse-than-expected reports released this month on employment, retail sales and consumer prices have spurred concern energy prices are crimping economic growth and fueling faster inflation, and helped send the S&P 500 and the Dow average to their 2005 lows last week.

Banerji says that while the deceleration in the pace of economic growth may continue in the short-term, many of ECRI's longer-term leading economic indicators are edging up, indicating that the economic "soft patch'' may be near its end.

"Some investors have been spooked by indicators such as employment and retail sales data, he said. "These are classic examples of investors focusing on the past. They tell you where the economy was in March but very little about where it is heading.''