Markets Too Calm About Oil Price, Morgan Stanley Wealth Says

(Bloomberg) -- Markets aren't adequately pricing in the risks from higher oil costs, according to Morgan Stanley Wealth Management.

Rallies in stocks and Treasuries that have taken the S&P 500 Index to a record high and 10-year yields down to around 2.5 percent illustrate that investors are complacent about crude prices, Morgan Stanley Wealth Management Chief Investment Officer Lisa Shalett wrote in a note released April 29. That's despite U.S. moves to cut off Iranian exports, a slump in Venezuelan production and Libyan supplies coming under threat.

“Markets continue to celebrate gains in every asset class as a validation of central bank forbearance and the resumption of Goldilocks conditions,” Shalett said. Yet “if oil remains at current levels through year-end, headline CPI could breach 3 percent, creating a problem for the Fed, cutting into consumer purchasing power, pressuring corporate profits and imperiling the growth in China and the emerging markets,” she said.

Read more about what oil at $100 would mean for the world economy.

Brent crude and WTI recently rose to the highest levels in almost six months after the U.S. announced tighter sanctions on Iranian crude, though have retreated slightly since. Brent climbed 0.3 percent to $72.22 a barrel as of 8:59 a.m. in London. Prices may stay elevated or rally further should the Organization of Petroleum Exporting Countries and its allies extend supply curbs when they meet in June, as some observers anticipate.

U.S. energy stocks are underperforming crude to a degree unseen in 10 years, “perhaps the most compelling evidence” that markets aren't anticipating higher oil prices, according to Shalett. She suggested using cheap oil shares as a defensive hedge in portfolios that are overweight U.S. growth stocks.

Shalett's not alone in recommending them: JPMorgan Chase & Co. said in early April that energy equities were poised to gain, citing valuations at multi-decade lows.

“While year-over-year price gains for oil and gasoline seem benign, if they remain at current levels, there will be much tougher year-over-year comparisons by the fourth quarter,” Shalett wrote. “That could prove challenging for many asset classes which have yet to price the risk.”

--With assistance from Grant Smith and Heesu Lee.

To contact the reporter on this story: Joanna Ossinger in Singapore at jossinger@bloomberg.net

To contact the editors responsible for this story: Christopher Anstey at canstey@bloomberg.net, Andrew Janes

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