Spillover effects from this swift and precipitous plunge in oil prices have crushed energy stocks as well as other investvestment categories such as High Yield bonds and Master Limited partnerships. These MLP’s, popular for their high yield and tax advantages earn money on the volume they move not on the underlying price of the oil and gas. In a panic babies are thrown out with the bath water.
Emerging market bonds and global stocks joined the retreat. Russia has became the poster child for what too much dependence on one commodity can do to your economy. Sanctions from Mr. Putin’s military actions in the Ukraine have reduced Russia’s capital flows and capital raising capacity. The Ruble plunged 50% and Russia’s troubles became a problem for the world of investments.
Many diversified bond funds lost net asset value as their portfolios have significant exposure to high yield energy companies which comprise about 20% of that market niche. At year end prices of losing assets tend to go even lower than seems rational as taxable investors lock in 2014 losses to offset earlier gains.
December which is typically one of the strongest months in the calendar year, up 1.7% on average, has so far proven to be just the opposite. The volatility of the past few weeks reminds us of October with wild swings in both directions. Yesterday the Fed came to the rescue again saying it would be patient before “normalizing “policy.
Long dated Government notes and bonds have soared in price this year as a flight to safety has prevailed. Rates of high quality debtors like Germany 0.58 %, U.K. 1.87% and Japan 0.35 % yield even less than U.S. 10 year notes. 10 year Treasury Inflation Protected Securities - TIPS have a nominal yield of 0.55 %. Bill Gross thinks they are a good buy here.
Our 10 year rates have dropped by more than a third since January from 3% to below 2% in mid-October. As you know the U.S. has seen rising employment and rising GDP in 2014. Not one of 67 Economists in a Bloomberg survey forecasted lower U.S. rates in 2014 this time last year.
Today you get paid 2.2% to loan the government your money for 10 years. This is attractive to many foreign buyers who get more yield than they do at home and benefit from a rising U.S. dollar exchange rate. In addition U.S. banks hold huge amounts of Treasuries as capital on their balance sheets encouraged to do so by bank regulations.
Diversification away from the highest quality US assets has be wrong footed in 2014 as other investments are nearly all lower in U.S. dollar terms.
Stocks in hard asset countries such as Canada, Mexico, Brazil, Australia and Russia are down 4.5%,16%, 22%, 12% and 45% respectively.
In Europe; France, Germany and the UK stocks are down about 14%. Japan and South Korea markets are down 7% & 14%. Only China +5% and India +19 % along with the US show gains.
The question is can US stock markets continue to rise with most markets abroad signaling recession? Additionally, will rates rise in the US next year or remain abnormally low due to international concerns?
Oil prices at these low levels benefit consumers worldwide. U.S. inflation numbers will be temporarily below the Fed's 2% target and cheaper energy costs should boost our GDP growth now projected at 2.6% to 3.0% by FED economists. A recession here looks highly unlikely as we have the world’s most diversified economy. The Fed is on hold for at least a few more meetings as of yesterday. While Ms.Yellen would like to “normalize” rates the FED seem fearful of doing so in this climate.
Continued US dollar strength will be a headwind against multinational profit growth. The 4th Q 2014 EPS growth was 3%. Full year 2014 SPX earnings according to Factset will be $119.09, up 7% year over year and at $128.38 up 7.8% for 2015 .
Central bank money printing has helped owners of financial assets far more than the average American or the retired saver. Now these tactics are being embraced in Japan and to a lesser extent in Europe with little economic effect except record low interest rates.
Every forecast we have seen from Wall Street now sees higher stock prices ahead for 2015 .
A Santa Claus rally should lie ahead over these final 8 trading days of the year. There is an old saying, if Santa Claus should fail to call Bears may come to Broad and Wall.
The 67 “wrong way eeconomists” who took the Bloomberg survey noted this past year that market direction and interest rates are no easy call.
In the long run it pays to remember that 11.5% returns from stocks and the 5.21% returns from 10 year bonds are the historical norm from 1928-2013.
These returns are indeed earned by investors who are capable of staying the course. Volatility can be our friend but as it ramps emotions it is often our enemy.
Douglas Coppola
John Coppola
December 18, 2014
CFA is a Registered Investment Adviser. Advisory services are only offered to clients or prospective clients where CFA and its representatives are properly licensed or exempt from licensure. No representation is being made that the information presented is accurate, current, or complete, and such information
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