The Mideast Mess Could Make U.S. Markets Look Better

Libyan rebelsAs turmoil grips the Middle East, it's the "oil" part that Wall Street is worrying most about.

Soaring oil prices have been taking a toll on stocks as violence escalates in Libya. Some of the concern is well justified. Libya, after all, is a midsize player on the world oil stage, and as signs of unrest spread to Bahrain and Saudi Arabia, it's understandable that some investors are heading for the sidelines.

But there's no shortage of hype and fear-mongering, either. Predictions that oil might hit $220 a barrel by investment bank Nomura, for example, lead individuals to quickly jump to doomsday scenarios.

What to Keep in Mind

Savvy investors, though, should take a more balanced approach. The deterioration of Libya is far more troubling than the ouster of Hosni Mubarak in Egypt, and oil prices may remain justifiably elevated as a result. But also note that Saudi Arabia's pledges to pump more oil to compensate for Libya make the chances of cataclysmic spikes more remote.

Here's another key point to keep in mind: While higher energy prices will restrain overall global growth, they could hurt emerging markets far worse than the U.S. -- and that difference could also help boost demand for domestic stocks.

The most immediate concern is Libya. Plenty of blood has already been shed, and Libyan strongman Muammar Qaddafi has vowed to fight to the bitter end. Still, his grip on power appears to be waning, and a TV appearance Thursday seemed to strike a slightly more conciliatory tone.

A huge trouble yet to come is coping with the power vacuum that would emerge if Qadaffi were to be deposed, given the central role that tribal alliances play in the country.

"Tribal support is a key element that will decide both Qadhafi's fate and possible outcomes of the ongoing uprising -- and currently the role of many tribes remains ambiguous," analysts at political risk consultancy Eurasia Group wrote in a note to clients this week. "The tribal element directly impacts the loyalty of the armed forces, and Qadhafi remains very skilled at exploiting the fragmented tribal system that dominates Libyan society."

Who Suffers More?

Qadaffi's ouster, in other words, wouldn't be the end of Libya's problems but the start of a new set.

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Among those problems will be the continued fallout for oil markets and higher energy costs on economic growth. Analysts at investment bank Merrill Lynch recently noted that emerging-market energy importers like India, China, Korea and Indonesia are particularly vulnerable to spiking energy costs.

But the post-industrial U.S. economy has actually grown less energy-intensive over time. And the energy sector itself now represents just 5.4% of U.S. GDP compared to 10.6% in 1980, the analysts note.

The U.S. also has cheap and abundant natural-gas resources to soften the low of higher oil costs, especially for power generation and industrial uses.

All of this bodes well for the relative attractiveness of a U.S. economy that continues to deliver better-than-expected data.

Adding to a Tailwind

Recall that not long ago, the "new normal" scenario that was taken as gospel on Wall Street held that investors would have to flock overseas to find growth as the U.S. looked at years of malaise. That scenario has proven to be vastly overblown.

But higher oil prices and a renewed premium on safety could add another tailwind to the growing enthusiasm for U.S. investments already under way. Corporate profits continue to boom, and cash-rich companies are returning capital to investors via buybacks in a sign of business confidence. The chances are now rising that this capital will get redeployed in the U.S. given the rising tensions overseas.

There's plenty of paranoia about what oil prices blasting higher would mean for the U.S. economy. But investors shouldn't overlook the good possibility that elevated prices would also have a silver lining for U.S. financial markets.
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