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When the Tide Goes Out, You Can See Who’s Swimming Naked

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That is from Warren Buffet and it highlights the implications of dramatic moves in asset prices – like oil. They reveal excesses and in this case can lead to oil-related financial crisis. We are seeing some of this play out in the HY market where yields on energy debt are spiking. It’s also hurting major oil producing countries.

Russia is a petro currency with the government getting ½ of its revenues from oil and gas. The MICEX stock index is off 47% this year mainly because the ruble has lost 44% vs the dollar. The central bank in Russia hiked rates to 17% on Monday in an effort to stabilize the ruble. It also provided a grim outlook for 2015 saying that in a “stress scenario” where oil remains below $60, the economy could contract by 4.5%.

Banks across Russia have reported running out of euros and U.S. dollars as consumers scrambled to exchange rubles for more stable currencies. After two days in free fall, the currency recovered later in the week to about where it stood a week ago. (It hit 80 rubles to the dollar on Tuesday and ended the week closer to 60.)

Meanwhile, the Swiss National Bank plans to roll out a negative interest rate Jan. 22, something it hasn’t done since the 1970s. The intent is to get investors to think twice before jumping into the Swiss franc, a safe-haven currency, in light of the falling ruble.

While one might hope Putin will learn his lesson and play nice, it is doubtful. In fact, military spending in Russia is set to rise 30% next year. Plunging oil prices may just make the Russian bear more belligerent.

The WSJ noted Thursday that in his annual press conference, “Russian President Vladimir Putin adopted a harsh tone with the West and defiantly vowed to ride out his country’s economic troubles, which he said would pass in two years.”

So while falling oil prices would seem to be good news (It is, really – in the long run) the risks of a systemic fall out from plunging oil prices is taking its toll as contagion takes hold near term.

By the way, the 1998 Russia Crisis, which helped precipitate the LTCM meltdown, was associated with a -61% plunge in oil prices. The S&P had a -19% correction during this episode, but ended the year up +27%.

The Fairy Godmother of the bull market strikes again!

That is how economist Ed Yardeni describes Janet Yellen – head of the Federal Reserve.

The Fed met last week and announced that they are “beginning to normalize the stance of monetary policy”. Janet Yellen and her colleagues finally removed the language in their monetary policy statement that short-term interest rates will remain at essentially zero for a “considerable time” and replaced it saying that the Fed will be “patient” before starting to increase rates.

Furthermore Yellen said in her Wednesday press conference that rates wouldn’t rise for a couple of meetings – meaning two. So look for June 2015 to be the first rate hike! She also affirmed that the FOMC sees the fall in oil prices as a positive development for the US economy. She implied that a tightening labor market will trump near-term oil-related weakness in inflation.

ISI’s overall take-away was that the statement was unambiguously hawkish relative to market expectations for the path of rates. Whatever; stocks rallied hard and bonds sold off on Yellen’s comments. In fact stocks had their best two day rally in nearly two years midweek after a rocky start on Monday and Tuesday. This is why you don’t try to time the market!

The S&P 500 gained 3.5% for the week (recouping last week’s losses) and closed at 2071 – close to its all-time high of 2075. Bonds sold off 10 basis points with yields on the ten year Treasury rising to 2.17%.

In economic news:

-November’s headline CPI inflation rate fell a more-than-expected 0.3%. That puts the y/y headline gain at 1.3%. The y/y gain for the core CPI (ex food and energy) is 1.7%, slightly less than expected. Gasoline prices plunged and will pressure inflation in December as well.

-Inflation in the Eurozone is only 0.3% y/y through November and many economists expect it to go negative in December to -0.1% y/y. More pressure on the ECB to ease further and engage in sovereign bond buying.

-November industrial production rose 1.6% in November, the biggest gain in 9 months, while October’s data were revised higher.

-The US leading indicator index rose a more than expected 0.6% in November.

On a lighter note!

Years ago while working in NYC I watched a Christmas Eve TV broadcast. The announcer ended the nightly news with something like this:

“Tomorrow will be Christmas. To those of you who are Christians; Merry Christmas. To those of the Jewish faith; Happy Hanukkah. And for the atheists in the crowd; have a nice day.”

We will be taking the next two weeks off and will be back January 9 with market returns for 2014 and will soon be publishing our 2015 outlook. Have a wonderful holiday season everyone.

Jeff Pantages
Chief Investment Officer

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