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Volatile Markets Across the Board

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PantagesStocks, bonds, oil, foreign, domestic, whatever; we are seeing more market volatility coming mainly from the collapse of oil prices. Oil is below $60 per barrel, down almost -45% since the June highs and currently at 5 year lows. That creates winners and losers. Losers include the oil companies and oil exporters like Russia, Iran and Venezuela. Winners include the airline industry, and oil importers such as Japan, China, and Europe.

While stocks fell this week in the U.S. (the S&P 500 was down -3.5% and got clobbered Friday) they are up 10.5% year to date. Of course smaller stocks have lagged badly after a terrific 2013. The S&P 600 small stock index has gained 2.3% year to date.

Meanwhile falling inflation and very low rates abroad has given U.S. bonds a boost. The ten year Treasury dropped almost 20 basis points in yield this week to close at 2.08%, down almost 100 basis points from the beginning of the year.

But junk bonds have taken it on the chin – mainly because energy bonds constitute 14% of the U.S. high yield market and liquidity is poor these days. Junk bond funds have seen outflows of late and the dealer community is in no hurry to support the market. HY bonds now yield over 7% and provide about 5% more yield than Treasuries. (APCM owns none – for now.)

Lots of News this Week:

Greek stocks fell a mindboggling -12.8% on Tuesday and continued to struggle as they were down -20% by Friday. Presidential elections are being brought forward to December 17 and the polls show Syriza – a radical left wing group – is leading the pack. The group wants to impose major haircuts on bondholders and cancel the existing (“austere”) bailout program. So, there are headline risks and a possible spillover to other markets. However, Greece is small and much of this is already priced into the market. It does put more pressure on the ECB to ease early next year.

FT reports on Tuesday:  “Chinese stocks, the yuan and corporate bonds suffered their largest tumbles in years after Beijing took fresh steps to rein in growing risks in the country’s debt-laden financial system. The Shanghai Composite slumped -5.4% to record its biggest fall since 2009, after a regulator banned investors from using low-grade corporate debt as collateral to borrow cash.” Still, the Shanghai Composite is up 39% YTD and retail sales were up 11.7% YoY in November. ISI notes: “China is hardly falling apart.” And China’s state media noted the need for slower growth and more structural reforms ahead of a conference aimed at setting economic policy for the coming year.

More evidence of low global inflation: Prices paid by Chinese consumers rose 1.4% in November compared with the same month last year. The increase was the slowest in five years.

The IMF is raising its forecast for U.S. growth next year to 3.5% from its last estimate of 3.1%, partly because of lower expected energy costs. Last year, consumers spent $371 billion on gasoline and $27 billion on heating oil. Next year they could save a total of about $175 billion, or $1,510 per household.

In the U.S. generally good economic news this week:

  • Headline PPI inflation fell -0.2% in November after a 0.2% gain in October. That puts the YoY increase at 1.4%.
  • Consumer sentiment in the 1st half of December rose more-than-expected to 93.8 from 88.8 in November.
  • Retail sales posted a 0.7% increase in November following an upwardly revised 0.5% increase for October. The jump in sales was the strongest monthly reading in eight months.

Standard & Poor’s lowered the sovereign credit rating of Italy from BBB to BBB-, which is one step above junk. It cited low competitiveness and weak growth as evidence that public debt might not be sustainable.

Fitch Ratings said it has placed Japan’s government debt on Rating Watch Negative, indicating that a downgrade is being considered. Fitch cited Japan’s decision to delay a consumption-tax increase as problematic. Recall Japan has elections this Sunday which should be a shoo-in for Prime Minister Shinzo Abe.

As for next week:

The Federal Reserve meets next Tuesday and Wednesday and might drop its assurance that short-term interest rates will stay near zero for a “considerable time” and replace it by saying the Fed will be patient before moving rates.

APCMs Bill Lierman notes that with the drop in oil prices, inflation expectations are significantly lower and moving away from the Fed’s self-imposed 2% inflation target. And the Fed is still tinkering around with its exit tools. It still needs a few more quarters to feel comfortable to ensure that it can establish a floor and manage short term interest rates. Janet Yellen’s press conference should be interesting.

Jeff Pantages
Chief Investment Officer

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