The US market experienced a sharp sell-off on Friday. That’s the headline. What’s important, is that Friday was not capitulation. It was as the headlines suggest… a sharp sell-off.

Further evidence that we are not at a shock and awe endgame for stocks can be found in the volatility indexes. Option volatility on both sides of the border shot up. The VIX (CBOE Volatility Index) closed at 23.56 up 4.93 on the day. The Mx Implied Volatility index closed at 20.48 up from 16.77. Most of the Mx data, coming in the last hour of trading, when the TSX 60 index began to follow the Dow lower. But none of these numbers suggest a blow out.

So far, the Canadian market has been saved by oil. In fact, the Canadian market may see more upside. Especially if oil hits US$150 per barrel by July 4th, which was the latest prediction from Morgan Stanley. But believing that oil alone will save Canadian investors, is premised on oil being in a sustainable long term uptrend. That’s a risky bet, which may well end on a very slippery slope.

At US $150 an barrel, the impact at the gas pump will hurt the US consumer… badly! Even the latest uptick will push US gas prices above US $4 per gallon nationally. That means substantially less disposable income for the consumer, which will negatively impact US GDP growth significantly. Job losses will escalate, as they have been… US unemployment above 5.5% at last count. When traders begin to understand the true impact of US $4 gasoline, we will see capitulation in the financial markets. And then we will see oil prices receding. As they always have.

The question is at what price do we find equilibrium between supply and demand. In my mind, its’ probably somewhere south of US $110 per barrel. Which is still a rich price point, and one that will keep the lights on in companies like Suncor (TSX: SU), Encana (TSX: ECA) and Canadian Natural Resources (TSX: CNQ). But it is a price point where US economic growth seems to be sustainable and profit margins at the oil companies will continue to flourish. The so-called post capitulation endgame.

The real risk to the financial markets is if oil’s surge is real and prices actually stay at the US $150 mark. At US $150 per barrel, a US economic slowdown will translate into a serious meltdown, that will make the 394 point slide on Friday seem like a walk in the park.

Canadians will not be immune to the risk either. We will likely not experience as serious a meltdown, but oil alone will not stop the bleeding.

Especially when you combine higher oil with lower real estate prices and continuing write downs in the credit markets. That lethal combination means that we are once again, starring into the abyss. This time being pushed to the brink by abstract predictions with speculative time lines from major investment banks.

Coming full circle, does anyone else think it odd that a major analyst at a major US investment bank, would make such a glaring time sensitive prediction? One by the way, that Morgan Stanley (NYSE: MS) was proud to say that they too, were putting their money where their mouth is. Taking a serious speculative position on the basis that their analyst is right.

Almost seems like Morgan Stanley was making a Hail Mary pass hoping to fatten their balance sheet prior to the release of their next earnings number. If so, that speaks to an even more serious issue, the health and long term sustainability of Wall Street most venerable investment banks.

If true, and I have no evidence that it is, it spells more trouble at CIBC (TSX: CM), which is by far the largest Canadian player in the US credit crisis game. It also suggests that buying short term puts on CM or any of the US investment banks (Lehman Brothers NYSE: LEH, Goldman Sachs NYSE: GS or Merrill Lynch NYSE: MER) may be a better strategy than betting on US $150 oil.