Falling Oil Prices Cause Jitters, but the Economy Stays on Track
The dominant financial story last week was the concern over the continued slide in oil prices, which have dropped close to 40% so far this year.1 Worries about the growing power of the Greek opposition party Syriza, and the potential effect on European policy should it assume control over the government, also contributed to investor unease. For the week, the S&P 500 Index fell 3.5%, snapping a seven-week winning streak and suffering its largest one-week pullback since May 2012.1 Energy stocks led the decline, while some defensive sectors such as utilities fared better.1 High yield bonds also sold off and investors poured money into Treasuries as risk aversion spread.1
The Benefits of Lower Energy Prices Outweigh the Risks
Falling oil prices do present risks. Lower prices hurt energy producing companies and regions and, as we saw last week, any sudden or sharp moves in financial markets can spill over onto other asset classes. Overall, however, we believe lower oil prices will help economic growth. Consumers should benefit most, as money spent on gasoline and heating costs can be redirected to other areas.
Weekly Top Themes
1.This week’s Federal Reserve meeting may mark an important shift in tone. Specifically, we expect the Fed could drop the phrase “considerable time” when discussing how long it intends to keep the fed funds rate near zero. This would mark the beginning of a multi-month process of preparing the markets for the first rate hike, which we believe could occur in mid-2015.
2.Strong retail sales figures act as additional evidence of improving economic growth. Sales climbed 0.7% in November, the strongest gain we have seen in eight months.2 These results should help assuage any concerns about a weak holiday shopping season.
3.Small business confidence is rising, which should help employment gains. November’s Small Business Optimism Index rose to its highest level since 2007.3 Since small businesses typically drive jobs gains during economic expansions, this bodes well for the future of the labor market.
4.Inflation remains low, and there is little sign that expectations will rise. Despite a months-long trend of economic data that have been exceeding expectations, inflation levels remain subdued. Lower oil prices and a stronger U.S. dollar are helping to keep downward pressure on inflation.
5.The history of the presidential cycle suggests equities could benefit in 2015. Next year will mark the third year of the presidential cycle. Since 1950, the S&P 500 Index has averaged a 16.5% annual return during those third years.4 In particular, January has been a strong month, showing a 4.3% average return with only one decline during that period.4
We Suggest a Continued Focus on Equities, Avoiding Energy and Resource Investments
Oil prices are likely to remain volatile and downward pressure will persist unless production levels are cut or demand rises. Additionally, it will take some time to fully feel the beneficial effects of lower prices. Before that happens, there is a risk volatility will contribute to uncertainty about the economy and financial markets.
However, the lesson from the 1986 oil market crash (when prices dropped 65%),1 is that the negative effects were short-lived and massive stimulus that followed more than offset any problems.
We would encourage investors to focus on the long-term benefits of the current disruption. We have not seen widespread financial or banking system problems due to lower oil prices and we expect policymakers to be sensitive to any economic issues that ensue. The six- to twelve-month economic outlook has improved as a result of the slide in commodities. We think energy and resource investments look challenging right now, but the backdrop should be conducive to improving equity markets. Investors should be on the watch for signs of stability in oil prices, which could signal a renewed upturn in equity markets.
1 Source: Morningstar Direct and Bloomberg, as of 12/12/14 2 Source: U.S. Department of Commerce 3 Source: National Federation of Independent Business 4 Source: Strategas Research
The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. Euro STOXX 50 Index is Europe’s leading Blue-chip index for the Eurozone and covers 50 stocks from 12 Eurozone countries. FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. FTSE MIB Index is an index of the 40 most liquid and capitalized stocks listed on the Borsa Italiana. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. The MSCI World Index ex-U.S. is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets minus the United States. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.
RISKS AND OTHER IMPORTANT CONSIDERATIONS
The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Non-investment-grade bonds involve heightened credit risk, liquidity risk, and potential for default. Foreign investing involves additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. Past performance is no guarantee of future results.
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