Wherefore art thou Santa? After an initially positive reaction to the Fed’s decision to raise interest rates and the rather dovish language that accompanied the announcement, global risk assets sold off in the back half of the week pushing equity markets further into negative territory for the month. Many had hoped that the Fed’s decision to finally move away from ZIRP (Zero Interest Rate Policy) would instill investors with confidence that the economy is gaining strength and catalyze a market rally into year end. So far those Christmas wishes are nothing more than “visions of sugar-plums dancing” in investors heads. Though there is time yet for a year-end rally, over the long-term fundamentals matter and future equity market gains will more likely come from rising profits than P/E multiple expansion…. yet, evidence of the former is scant at this time.
Additional asset class performance detail can be found here.
First Time? The Fed’s move marks the first interest rate increase in more than ten years. As a result of the timing between now and the last interest rate hike, there is a generation of traders that have not experienced a rate tightening cycle. The absence of a declining rate tailwind will test both the newbies and the veterans, providing an opportunity for the truly talented traders to separate themselves from the pack.
Scary Movie. Last week Bloomberg ran a piece highlighting potential market risk scenarios based on a survey of more than 100 economists. This survey identified the top three risks as:
1. The price of oil spiking to over $100 per barrel in reaction to Islamic State attacks.
2. The U.K. exiting the European Union
3. A cyber-attack taking down the financial system
I will suggest another risk that is on my radar: Operating in unchartered territory, a major central bank (US, ECB, BOJ, or PBOC) commits a monetary policy error that plunges the global economy into another deep recession.
This is frightful stuff no doubt. But is it any scarier than other periods in history, such as the Cold War between the U.S. and Russia? Markets are always facing risks (known and unknown). Sometimes these risks come to the fore as an “event” resulting in large market dislocations, such as the 9/11 terrorist attacks (2001) and wars with Iraq parts I (2003) & II (2007). However, more often than not the risks are thankfully unrealized. I’m not suggesting that the risks cited by Bloomberg should be ignored, rather I’m positing that investors need to take these risks into consideration and refrain from concentrating portfolios in a single asset class (even if that asset class has performed well recently – strike that, especially if that asset class has performed well recently). Spreading portfolio risk allows investors to participate in market appreciation during good times, manage downside risk during bad times, and rebalance to sell high and buy low. Long story short (and in a not-so-subtle nod to Dos Equis beer’s “Most Interesting Man in the World”), I urge you to stay diversified my friends.
Economic Data Release Summary. Annual Inflation, as measured by the Consumer Price Index, climbed to 0.5% (from 0.2%) in November in spite of a 2.4% month-over-month (m/m) decline in gasoline prices. Core inflation (excluding food and energy) rose to an 18-month high of 2%. On a shorter-term basis, three-month annualized core inflation is running at 2.4%. In spite of the higher inflation rates, we don’t believe we are in the beginning phase of runaway inflation. For one, the uptick in inflation was aided by weak year-over-year comps and negative inflation rates rolling out of the calculations. Moreover, with credit growth slowing on a global basis we just don’t see evidence of widespread inflationary pressures globally or in the U.S. Of course, if the data changes, we’ll change our view accordingly, we just don’t see evidence to do so at this time. Industrial Production in November declined 0.6% m/m vs. expectations of -0.1% as utilities (warmer weather) and mining output fell more than anticipated. If there was a bright spot in the report it is that manufacturing output was stable in November vs. consensus expectations of 0.1% decline.
In other news, the House of Representatives passed a spending bill on Friday that will fund the government through Sept 2016. Perhaps more importantly, the bill lifted the 40-year old ban on exporting oil from the U.S. (too bad the politicians didn’t make this decision when oil was priced above $100 per barrel).