Oil Surge Will Have Wall Street on Edge

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With oil prices pushing new record highs, Wall Street analysts said the market may need to see an easing of that pressure for stocks to rise next week.

"The market, as far as stocks are concerned, it's been amazingly resilient in the face of some very bad news, particularly about oil prices," said Michael Metz, chief investment strategist at Oppenheimer & Co., of New York.

Even after oil closed at $66.80 a barrel on the NYMEX (search) Friday, up $4.49 for the week, the blue-chip Dow Jones Industrial average and broader Standard & Poor's 500 index managed to hold mild gains for the week. But given that rising crude prices eat into consumer discretionary spending and drive up corporate costs such as energy and chemical raw materials, Metz questioned how much longer investors could shake off the surge in oil prices.

"If we do have oil prices at this level for another week or so, it's going to make investors reconsider the whole outlook for consumer demand, which of course has been the real fuel for the economy," Metz said.

Analysts will also be watching key government reports on inflation -- the Consumer Price Index (search), due out Tuesday and the Producer Price Index (search), to be released Wednesday -- for any sign of how much longer the Federal Reserve will continue raising interest rates.

The Fed on Aug. 9 raised its benchmark funds rate for the 10th time, to 3.5 percent. The policy-setting board has been raising rates since June 2004, with an eye toward preventing the economy from overheating and keeping inflation in check.

Labor Department (search) figures are expected to show that, in July, the prices of goods paid for by consumers rose 0.2 percent, and by businesses 0.1 percent, factoring out volatile food and energy prices, according to economists polled by Reuters.

"There have not been any big blips in inflation (so far this year)," said Ernie Ankrim, chief investment strategist at the Russell Investment Group, of Tacoma, Washington. That has allowed the Fed to stick to its pace of quarter-point rises.

But if either the CPI or PPI figures showed inflation grew at a much faster-than-expected rate, as little as 0.2 percent or 0.3 percent ahead of forecast, that could be a sign the Fed would extend or even accelerate its pace of rate increases, which would take a toll on stocks.

Higher rates are typically negative for stock prices since they raise the cost of borrowing for people and companies.

"We're all looking to see when the Fed will stop increasing short-term rates," said Ankrim.

U.S. companies are coming to the end of their flurry of second-quarter earnings reports and have generally topped Wall Street's expectations so far this quarter.

Of the 457 companies in the Standard & Poor's 500 index (search) that have reported results so far, 83.4 percent met or beat analysts' forecasts, according to Reuters Estimates.

Next week's earnings calendar is weighted toward retailers, who represent 9 of the 19 S&P 500 companies due to report. Investors will scrutinize reports from heavyweights such as Wal-Mart Stores Inc. (WMT) and J.C. Penney Co. Inc. (JCP) for any warning signs of slowing consumer spending.

While most major retailers have already reported second- quarter sales, their earnings will reveal how heavily they relied on price promotions -- which typically sap profit margins -- to drive shoppers into their aisles.

"The economic strength that we've seen in the last six weeks has been what I call deflationary," said Ned Riley, chief executive officer at Riley Asset Management, of Boston.

He noted that U.S. automakers and computer vendors -- including Dell Inc. have discounted heavily to spur sales.

Overall, strategists said, the biggest risk stocks are facing is that rising prices at the gas pump, fueled by crude's surge, will cause consumer spending to slip.

"Even if it's trivial things like people don't buy another pizza, this, on the margin, has an effect on the economy," said Ankrim, of Russell.