Economic Update 12-21-2015

• The most significant piece of economic data for the week was the FOMC’s decision to raise the fed funds rate for the first time in a decade, as overall conditions appeared stable enough to policymakers to withstand such a policy shift.  In other news, several industrial indicators continued to show some weakness, inflation remained tempered and monthly housing stats came in stronger for the prior month.
• Equity markets began strongly in advance of the FOMC meeting, but gave up gains by week’s end.  Interest rates ticked slightly higher, which brought down bond returns during the week.  A trend of a strong dollar and low oil prices continued, which negatively affected commodity prices.

Stocks performed well early in the week, prior to and just after the FOMC rate hike announcement, but pulled back late.  Friday was also subject to ‘quadruple witching’, which refers to a date on which a variety of stock options and index futures all expire at once, which can tend to exacerbate volatility dramatically due to last-minute positioning.  From a sector perspective, defensive utilities and telecom outperformed with positive returns, while energy/materials and technology lagged, with losses.

Abroad, perhaps surprisingly, emerging markets came in with a strong showing, perhaps as investors realized higher U.S. rates wouldn’t mean the end of things for their part of the world. South Africa was the surprising winner, gaining over +10%, but due to internal factors related to an abrupt change in finance ministers, than from fundamentals.  China, Mexico and India were among other winners, which helped the emerging group gain ground on the week.  On the other side, commodity-sensitive nations, such as Brazil and Russia, as did Japan, following a surprise announcement of additional BOJ stimulus and was coupled with a yen decline.  This is perhaps another example of a perhaps-usual positive reaction being upended by imperfect communication.

Another foreign event that has cropped up is China’s decision to add another wrinkle in the yuan currency story.  Chinese officials have decided to break their traditional peg to the dollar (many forget they have one), and instead will use a basket of currencies as their pegging instrument.  The conspiracy theorists out there have taken this as the next step in the dollar losing its supremacy as the global reserve currency, but due to the dollar’s strength as of late, this move naturally made sense as a backdoor way to weaken the yuan.

U.S. bonds fell in price slightly as interest rates ticked upward.  Surprised?  Due to the high levels of transparency by the Fed, the rate hike was largely baked into expectations, so the immediate impact was actually subdued.  As always, it’s the surprises that hurt.  Also interestingly, emerging market (esp. local currency) bonds rallied as investors perhaps realized the impact of the Fed won’t be quite as bad as first feared.  On the negative side, high yield indexes rebounded strongly early in the week following the prior week’s market credit concerns, but fell back again due to additional weakness in energy.

Real estate rallied, again oddly, led by U.S. mortgage, residential and retail.  The impact of rising rate policy on real estate can be complicated, as long-term rates are more meaningful in borrowing costs than are short-term, and the Fed signal of a strong-enough economy to raise is a plus for real estate fundamentals, such as tenant demand.  Interestingly, the congressional budget bill that passed last week including a relaxation of restrictions on foreign investment in U.S. real estate, which could be seen as a positive due to the possibility of new sources of funding capital being made available.

Commodities lagged on the week with the influence of a stronger dollar, but energy was the primary culprit as other segments only suffered marginally.  Crude oil bounced around in a fairly tight range, ending in the mid-30’s, while natural gas was hit harder from warmer-than-seasonal weather which reduced inventory drawdowns—causing prices to fall -25% over the past month.  From another angle, last week’s congressional budget bill has the potential of affecting this asset class as well, as it proposed the removal of the 40-year export ban on U.S. crude. Reaction is mixed, as it would naturally benefit exporters of crude directly, but likely hurt refiners (although they’re being given a tax break to help ease the pain).

We wish you and your families a safe and happy Holiday season.

Sources:  LSA Portfolio Analytics, American Association for Individual Investors (AAII), Associated Press, Barclays Capital, Bloomberg, Deutsche Bank, FactSet, Financial Times, Goldman Sachs, JPMorgan Asset Management, Kiplinger’s, Marketfield Asset Management, Minyanville, Morgan Stanley, MSCI, Morningstar, Northern Trust, Oppenheimer Funds, Payden & Rygel, PIMCO, Rafferty Capital Markets, LLC, Schroder’s, Standard & Poor’s, The Conference Board, Thomson Reuters, U.S. Bureau of Economic Analysis, U.S. Federal Reserve, Wells Capital Management, Yahoo!, Zacks Investment Research.  Index performance is shown as total return, which includes dividends, with the exception of MSCI-EM, which is quoted as price return/excluding dividends.  Performance for the MSCI-EAFE and MSCI-EM indexes is quoted in U.S. Dollar investor terms.                                                                               

The information above has been obtained from sources considered reliable, but no representation is made as to its completeness, accuracy or timeliness.  All information and opinions expressed are subject to change without notice.  Information provided in this report is not intended to be, and should not be construed as, investment, legal or tax advice; and does not constitute an offer, or a solicitation of any offer, to buy or sell any security, investment or other product.