Oil, CPI may give stocks a rough ride

By Walker Simon

NEW YORK (Reuters) - Wall Street may be in for a rocky ride this week as investors recall Friday's triple threat -- oil at a record above $139 a barrel, a troubling unemployment report and the stock market's 3 percent drop -- while they await inflation data for May.

The Consumer Price Index is set for release on Friday.

Stocks had been headed for a weekly gain after Thursday's rally, the strongest in more than a month. But optimism evaporated early Friday when the government said the unemployment rate scored its sharpest one-month spike in 22 years in May. The Labor Department said U.S. nonfarm payrolls lost 49,000 jobs.

For the week, the Dow Jones industrial average .DJI fell 3.4 percent and the Standard and Poor's 500 index .SPX tumbled 2.8 percent. The Nasdaq .IXIC dropped 1.9 percent.

On Friday afternoon, stocks accelerated their slide when oil soared past $139 a barrel. The Dow closed down almost 400 points. Skyrocketing oil prices and the stock market's sharp sell-off triggered memories of 1970s-style stagflation, when prices soared but economic growth was almost nil and the stock market was practically dormant.

"Stagflation is really a nasty word," said Victor Pugliese, director of listed equity trading at Broadpoint Securities in San Francisco. "The last time we had it, we had a terrible market."

NIGHTMARE ON WALL STREET

Stocks went almost nowhere in the 1970s when oil prices surged due to the Yom Kippur War and the Arab oil embargo in October 1973, and at the decade's end, with the U.S. hostage crisis in Iran that began in early November 1979.

In early 1973, the Dow broke the 1,000 mark for the first time -- only to end the year at 850.86. The Dow rose above the 1,000 milestone again in 1976 and managed to close out the year at 1,004.65. It would take the Dow more than four years, until sometime in 1981, to poke its head above 1,000 again. The market's stumbling block: Runaway oil prices and inflation took a bite out of the U.S. economy with banks' prime interest rate hitting 21.5 percent in December 1980.

"There is a lot of concern over how high the oil price can go," said John Praveen, chief investment strategist at Prudential International Investments Advisers LLC in Newark, New Jersey. "Stagflation clearly is the biggest fear with a negative impact on economic growth and the consumer."

WILL OIL HIT $150?

Oil roared to an all-time high Friday on the weaker dollar, tensions between Israel and Iran, and a Morgan Stanley forecast that falling U.S. crude stockpiles could push oil to $150 a barrel by July 4. That date marks the U.S. Independence Day holiday and the start of a long weekend for most Americans -- a time when demand for gasoline is usually high and airports are crowded.

During the New York Mercantile Exchange's regular session on Friday, U.S. crude oil for July delivery CLN8 climbed to an intraday record of $139.01 -- overtaking the previous record of $135.09 set on May 22. NYMEX July crude also settled at a record $138.54 a barrel, up $10.75, or 8.41 percent for the day. And that surge followed Thursday's gain of $5.49.

In Friday's post-settlement trading, NYMEX July crude shot even higher -- to a record $139.12.

The jump in the U.S. unemployment rate to 5.5 percent in May from 5.0 percent in April and Friday's spike in oil prices to a record dominated the weekend's headlines.

"That news is going to scare the daylights out of the average person," said Paul Mendelsohn, chief investment strategist at Windham Financial Services in Charlotte, Vermont. "You're seeing some bad follow (through) ... that could put pressure on the market."

In the week ahead, the U.S. Consumer Price Index for May will get more scrutiny than usual as Wall Street keeps inflation in mind. The CPI report, due on Friday, will be looked at to see whether soaring oil prices have spilled over into the core index, which excludes food and energy.

Economists polled by Reuters expect that the overall CPI rose 0.5 percent in May, compared with a gain of 0.2 percent in April. They forecast core CPI up 0.2 percent in May, after an increase of just 0.1 percent in April.

After the surge in the May unemployment rate caught investors off guard, particular attention will be paid to the May retail sales on Thursday for signs that consumers are less willing to open their wallets.

May retail sales are projected to have gained 0.5 percent, the Reuters poll showed. In April, overall retail sales declined 0.2 percent. Excluding autos, May retail sales are expected to have risen 0.7 percent, compared with a gain of 0.5 percent in April.

The market will look at the retail sales data "just to get a sense of how money is being spent," Praveen added, referring to the tax stimulus checks that have been mailed to consumers.

Monday's monthly pending home sales data and Wednesday's weekly mortgage applications report will be weighed for signs of a bottom in the housing downturn.

The Federal Reserve's beige book on Wednesday will provide an anecdotal assessment of economic health by region. The report plays a part in the Fed's decisions on interest rates.

The Federal Open Market Committee's next meeting is scheduled for June 24-25.

On Friday, short-term interest-rate futures did an about-face. Dealers cut the implied chances that the FOMC will raise benchmark lending rates as soon as October to less than 50 percent from more than 80 percent earlier in the day.

WALKING ON EGGSHELLS

Setting the tone over the weekend on oil prices could be any comments reinforcing the remarks by Israel's transport minister, who said an attack on Iran's nuclear sites looked "unavoidable," the most explicit threat yet against Tehran from Prime Minister Ehud Olmert's government.

"If we have any more of this kind of rhetoric on the weekend, then I'm sure there is going to be a spike in the oil ... and (there will be) a down (stock) market," Pugliese said.

Another worry is whether the credit markets will encounter more turbulence, depending on Lehman Brothers' ability to raise capital to shore up its balance sheet.

CNBC television reported that Lehman LEH.N was considering announcing earnings sometime in the coming week -- a week ahead of schedule -- to calm the market's fears about its liquidity.

Lehman's stock sank nearly 17 percent during the first two days of last week on speculation that the fourth-largest U.S. investment bank will report a larger-than-expected quarterly loss and be forced to raise as much as $4 billion of new equity. On Tuesday alone, Lehman's stock lost 9.5 percent, or $3.22, to close at $30.61 -- almost a five-year low -- on the New York Stock Exchange.

For the week, Lehman's stock fell 12 percent, while it has lost 50 percent of its value so far this year.

"One part of the (stock market) equation is financials (stocks)," Praveen said. "The big thing is hanging on Lehman and whether they raise capital and how successful they are."

He said disappointment with Lehman's earnings and balance sheet could ignite a sell-off in financial stocks, raising the prospect of the market testing this year's lows, set in March.

For the year, the Dow is down 1,055.01 points, or nearly 8 percent, while the S&P 500 is off 107.68 points, or 7.3 percent. The Nasdaq is down 177.72 points, or 6.7 percent for 2008 so far.

(Editing by Jan Paschal)