Merry Christmas and a happy and bright Hanukkah! The markets delivered gifts of the season a bit early. Playing Santa was Fed Chief Janet Yellen, as she indicated the Fed would be “patient” when deciding to raise rates. The financial markets took that to mean they would remain data dependent and the actual date/time of the next rate hike would be kept covered in Christmas snow. Winter fireworks are somewhat unusual, on Wall Street however, there were beautiful chrysanthemums and spiders displays exploding all about. The US economy continues to show growth, despite weaker global economies. The coming week we’ll get another revision to third quarter growth, which may be revised higher. If it comes in above 4%, it would mark the fourth in five quarters of 4%+ growth. While growth is certainly enough to get the Fed to think about tapping the monetary brakes, inflation remains barely above zero. The lower energy prices will keep a lid on consumer prices and help many companies improve their profits (by lowering costs). The Fed would like to see inflation rates north of 2%, however no amount of monetary easing has helped. Also reporting this week will be consumer income and spending. Estimates are for robust income and spending growth, so a weak number could spur bond investors to keep pushing rates down as the Fed will likely be “very” patient with rate increases.
After a slow start to the week, the markets added 3% to the prior Friday’s close. Led by the woeful energy sector, investors bought across the board and pushed stocks back to within hailing distance of all-time highs. The year has been marked by various 5-7% market declines that have reversed very quickly, sending stocks to new highs. Those waiting for the inevitable 10% correction have been frustrated, as investors are learning that any decline is to be bought and stocks will always rise as long as the Fed has their back. What normally takes months to unfold took only a few weeks as investors have moved from bullish to bearish and back again. The next two weeks will be marked by holidays, including the emperor’s birthday in Japan to Christmas to Boxing. Trading will likely be the slowest of the year and the averages should see modest gains into year end. Traders have stepped aside as capital gains have been booked and everyone will be waiting for the calendar to read 2015. Purely from a momentum perspective, stocks may drift higher as investors try to get ahead of an expected good January. The reality of 2014 is very different than the expectations coming into the year this past January. Investors enter 2015 in a festive mood.
The Fed announcement pushed prices down and yields up as investors left the safety of bonds to buy stocks. With the Fed keeping rates low, investors are more interested in taking the “risk trade” in stocks than the safety of bonds. Foreign buyers continue to be interested in our debt as rates here still exceed those in their home countries. Combined with a stronger dollar, international investors still benefit by buying US bonds. The bond model has been steadily positive all year, successfully “calling” lower rates this year. 2015 is not likely to be as smooth, or as surprising as 2014. Rates are expected to rise (again). But given the very low current rate environment, it wouldn’t be unexpected to see the model spend much of the coming year flipped back and forth from bullish to bearish views on interest rates.
Like a very large ball getting pushed under water, the eventual release creates a rapid rise. The timing is never certain, and until it happens, investors keep trying to “guess” where the bottom is and losing money along the way. Last week’s 9%+ pop may not be “the” bottom, but part of the bottoming process. Looking back at two other huge sector declines: technology between 2000/02 and financials between 2007/09, each sector declined by 50% from six months prior. Energy has managed to merely decline by 25%. In order to hit the “magic” 50% level, the sector would need to decline another 40% from Friday’s close. Technology stocks declined another two years after falling 50% in six months, while the 50% decline marked the bottom for financials. Energy stocks may not fall to that level, but a look at history is instructive to where prices may go from here.
The next two holiday shortened weeks are likely to have a slightly positive bias heading into the New Year. Although there will be plenty of economic data to review before year-end, market reaction is likely to be muted due to the usually slow trading activity. Bond investors have also been bounced around as the focus has shifted away from the risky high yielding sector toward the safety of highly rated corporate bonds and US treasury debt.
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.