Naughty or Nice
“Ho, Ho, Ho” has become “Uh Oh”, as investors worry more about the decline in energy prices and the upcoming Fed meeting than any Christmas cheer. The economy has bestowed a few gifts already this season as retail sales rose at their best monthly pace since March; lower prices at the pump should continue to provide some continued benefit to overall spending too. Consumers at least say they are confident as the latest report on consumer confidence is a decade high. There may still be coal in the stockings hung by the chimney with care as the Federal Reserve is set to announce monetary policy on Wednesday. A lengthy news conference will follow. There have been plenty of hints by Fed governors in the past week that they will be dropping “considerable time” from their assessment on how long interest rates will remain at zero. It is seen as a prelude to the start of higher interest rates starting sometime mid 2015. The debate about economic strength continues to rage though, as employment gains remain very strong, but inflationary pressures are weak. The Fed’s dual mandate is to shoot for employment growth and stable prices (which is seen as 2% annual growth). There are still a few more shopping days until Christmas and for investors to wrap up a good year. There is also plenty of time for that white Christmas to turn blue.
If a streak or record is broken, it is best to do it emphatically, leaving little doubt about the new record. That was done last week in stocks, as they not only broke their seven week winning streak, but put in their worst week in two years. There is some solace in that historically last week is usually the worst part of an otherwise good December. Whether investors will be able to pick up the pieces next week is yet to be seen. The decline puts the SP500 back to the close at the end of August, wiping out the modest gains since Halloween. Unfortunately, the decline has not moved many of the indicators toward “buy”, especially following the seven weeks of gains. The best guess would be for sloppy trading through the end of the year and maybe with a downside bias that would set the market up for a good start to 2015. It would be surprising to see another sharp rally similar to that in September/October following this decline. The wrangling over interest rates will likely be at the center of focus for investors this week: when will rates begin to go higher, how quickly will the Fed increase them and what will happen to stocks in that scenario. Stocks are likely to bounce around the Christmas tree rather than rock and roll this year.
Short-term bonds, (under two years to maturity), are beginning to price in a Fed tightening, as their yields have increased by a quarter point over the past two months. The long-term bonds remain very well bid, as their yields continue to decline. Some of the decline is certainly due to the rapid decline in oil prices, some due to falling stock prices and some due to better yields in the US vs. other developed countries. The increase in shorter term rates and decline in longer term bonds is flattening the yield curve. The “flattest” the curve has been in the past seven years has been roughly 2.5% and currently sits at 2.7%. It will be very difficult to “invert” the curve, as short rates should not rise too much, but the global worries are certainly pushing long term yields toward comparable yields around the world.
All other groups and sectors no longer matter, as the focus is solely upon energy. Energy stocks hit all-time highs just as we celebrated the 4th of July. It has been all downhill since. However when comparing energy to the SP500, the group price peaked exactly seven years earlier and had a minor peak again in July ’11. Today, relative to the SP500, energy stocks are back to those early in ’05. Energy is touching many other parts of the markets, from pressuring railroad stocks to helping out truckers and airlines. The recent decline has erased more than half of the gains (relative to the SP500) from ’99 to ’08. The bottom in ’99 took two years to develop after a long slide of under-performance to the broad market. So while energy stocks may bounce some here, it will take quite a while before they once again lead the market for more than a few months. It may be that lower oil prices (and those at the pump) will be here for quite some time.
The past week is noted to be the poorest week of the usually very strong month of December. It didn’t disappoint! The Fed meeting, announcement and press conference on Wednesday will be the focus for the week. IF energy prices continue to tumble, expect stocks to follow as they did last week. Bond investors should stay in the 7-10 year maturity range to avoid any issues around a surprise interest rate hike that could happen sooner than later.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.