Wall Street warily watching Iraq, oil prices

Tue Jun 17, 2014 5:09pm EDT
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By Rodrigo Campos

NEW YORK (Reuters) - Traders are bracing for more volatility in markets as fighting in Iraq intensifies, with the recent rise in crude oil prices posing risks to the strong rally in U.S. stocks.

Investors worry that the insurgent Islamic State of Iraq and the Levant (ISIL), which threatens to take control of northern Iraq, could extend its reach to the south and cripple oil production in OPEC's second-largest exporter. This week, fighting shut the country's biggest oil refinery.

Concern over Iraq was in part responsible for the S&P 500's .SPX largest weekly drop in two months last week, when prices for Brent crude LCOc1 jumped the most since last July.

"The spike in energy prices is a problem, since it isn’t coming on rising demand, just concerns about supply," said John Toohey, head of equities at USAA Investments in San Antonio. "High energy prices are sand in the gears of economic activity."

Prolonged fighting would boost volatility in stocks and in particular hit transportation, shipping and airline companies with a significant portion of their expenses from fuel costs.

Oil production in the north of Iraq has been down since March, but the prospect of supply disruptions in the oil-rich south has pushed the price of Brent crude to a nine-month high in recent days.

Bank of America Merrill Lynch analysts said in a note that $125 per barrel for Brent - near the highs hit in 2011 and 2012 - is on their watch list. Others have said the Brent peak near $150 in mid-2008 could be in play.

In that case, expect more weakness in transports and airlines. During last week's 4 percent rise in oil prices, the S&P 500 fell 0.68 percent. But the Dow Jones Transportation Average slid 2 percent and the NYSE ARCA airline index .XAL lost 4.9 percent. The 10-day correlation between the XAL and Brent is at -0.86, the strongest inverse relation since September.   Continued...

A Wall Street sign is pictured outside the New York Stock Exchange in New York, October 28, 2013.  REUTERS/Carlo Allegri