Will the oil price now depress capital markets?

The danger of a further dive in global stock market prices is now looming large because rising oil prices may trigger a hike in interest rates to cope with inflation.

Oil futures topped $27 this week as the conflict between Israel and Palestine intensified, and traders worried that the invasion by Israel might widen into a regional war. Such fears came on top of renewed concerns about US military action in Iraq sometime this year that would disrupt oil supplies.

Traders harked back to the oil price weapon of 1973 when the price of oil quadrupled virtually overnight. This also precipitated the worst post-war collapse in global equity markets.

Historical parallels are always dangerous. Opec does not have such a stranglehold over world oil supplies as it did in 1973. And few commentators really expect a wider regional war this time. But global equity markets are overvalued by historic standards, and that does leave them vulnerable to any sudden adverse shift in economic conditions.

No doubt if oil prices scale the $30 barrier then the United States will lean on its friends to increase oil supplies. However, it may well be that the oil price increase that we have already witnessed in the past few months is already enough to de-stabilize still fragile investor confidence, especially if the Central Banks decide to raise interest rates in response.

This factor might cause what economists call a double-dip recession. Indeed, five out of the past seven US recessions have been double-dip recessions, so the balance of probabilities suggests that a second fall in GDP is likely in any case.

Thus investors are best counseled to stay cautious and liquid. The best market opportunities always come when others are at their most pessimistic, and that position may not be far off.

So AMEInfo commentator Dr Marc Faber could yet be proved right in suggesting that recent share price increases have been a deceptive bear market rally.