Here Comes Santa Claus


, , , , , , , , , , , , , , , , ,

by Ralph Cole, CFA
Executive Vice President of Research

The Federal Reserve delivered some early Christmas cheer with a new policy statement on Wednesday, and by Thursday afternoon the Dow average had advanced 700 points. Please excuse us for being frustrated by the constant attention to the Fed and the parsing of every statement they utter. This tends to happen during any Fed tightening cycle. The chart below shows the average S&P 500 performance around the last five Fed tightening cycles. As you can see, about six months before the Fed starts raising rates the market goes through a correction of 5–7 percent and volatility rises.

Tightening Cycles

The U.S. economy continues to hum along, and there is no lack of positive economic indicators. We believe that the Fed will be raising short-term interest rates in the middle of next year and they are doing their best to signal that move to the markets well in advance. The most recent examples last week were jobless claims, which dropped to a six-week low, consumer comfort climbing to a seven-year high, leading economic indicators rising an additional .6 percent and retail sales increasing by the most they have in eight months. In short, there is plenty of good economic news to go around, and enough momentum for the Fed to justify raising rates next year.

Wind of Change

While oil prices fell modestly this week, energy stocks began to rally. Since the peak in oil prices in June, the S&P energy sector fell 25 percent. This week oil prices are down another 2 percent, but oil stocks in the S&P were up 7 percent. We can’t say that we are surprised. Whenever you get such a dramatic drop in prices, it tends to produce bargains. Financial buyers aren’t necessarily brave enough to step into these situations, but strategic buyers are. This week Repsol, a Spanish oil company, made an offer to buy Talisman Energy for $12.9 billion. Talisman’s share price was as low as $3.96 on December 8, and now trades for just over $9.00 per share. We made the case last week that the sell-off in oil was overdone, and it appears others are coming to the same conclusion.

Our Takeaways from the Week

  • The stock market will continue to experience increased volatility in the coming months as the Fed communicates its tightening plans
  • The sell-off in oil stocks is overdone, and there is value in the sector
  • Our warmest wishes for a happy holiday season!


Black Gold?


, , , , , , , , , , , , , , , , , ,

Shawn-00397_cmykby Shawn Narancich, CFA
Executive Vice President of Research


With the holiday season in full swing and U.S. investors rejoicing about another year of solid U.S. equity returns, most international investors may be forgiven for feeling like they are getting a lump of coal in their Christmas stocking. In an increasingly decoupled global economy, where China’s growth is slowing and Europe and Japan teeter on the brink of recession, 11 percent returns domestically reflect, in part, the increasingly attractive growth profile of the U.S. economy. What’s surprising is the fact that China’s stock market has risen over 30 percent so far this year, helping buoy emerging market equity returns in a year where stocks have fallen in most foreign markets. Providing better investor access to mainland Chinese equity markets (through linking the Hong Kong and Chinese markets) has helped stimulate investor demand, but the flow of economic data out of the Red Giant remains rather discouraging. Slowing industrial production growth, weaker retail sales, and moribund manufacturing activity all speak to the challenges that Chinese policy makers confront in transitioning the world’s second largest economy from an investment led juggernaut to one better balanced by consumption.

Leading the Way

In contrast, the U.S. economy is moving full speed ahead. The November retail sales growth that came in at the high end of estimates reaffirms our thesis of a healthier U.S. consumer boosted by healthy job gains, rising home prices and the falling price of oil. Healthy retail sales data bely the 11 percent sales decline over the long Thanksgiving Day weekend, indicating that the weak sales numbers were more a function of an earlier start to the holiday selling season. With government spending having apparently bottomed and capital spending on the rise, the error of estimates for Q4 GDP is once again higher.

Crude Thoughts

All of which brings us to the topic that seems to be on everyone’s mind nowadays – oil. Now down 46 percent since June, U.S. black gold is far from it at the moment. Yet we continue to believe that the fundamentals of oil aren’t as bad as the price implies. Developed economy inventories are near five-year averages, global demand continues to grow and, most importantly, because of oil’s correlation with economic growth, GDP globally continues to expand in a world of accommodative monetary policy. Contrast today’s environment with 2008, when oil plummeted over 70 percent in eight months, a washout that coincided with consumer price shocks from $4.40/gallon gas and a global economy on the verge of collapse. The best cure for low oil prices is low oil prices, and at today’s level of around $60/barrel, we expect global petroleum exploration and development spending to fall by 25 percent or more in 2015, sowing the seeds for tighter markets and higher prices.

Indeed, evidence of the supply response to come is already upon us. Lower prices are reducing oil companies’ cash flow, leaving them with less money to reinvest in new wells. We are just beginning to see U.S. shale producers announce their 2015 capital budgets and, so far, the anecdotes support our contention that investment levels will drop dramatically. Indeed, November’s new U.S. well permits number, down 45 percent sequentially, offers investors a taste of the supply response to come. Conoco has announced a 20 percent drop in its capital spending and small independent producer Oasis is cutting its 2015 cap ex budget by 44 percent. Dozens of other independent U.S. producers, those responsible for the domestic energy boom of recent years and which are largely responsible for doubling U.S. production over the past six years, will come to the confessional between now and the end of January.

With less money being expended to replenish reserves from shale wells that deplete up to 50 percent of recoverable reserves in the first two years of production, we expect the oil markets to tighten faster than investors currently believe. We would observe that the incremental U.S. liftings that have driven production growth globally are of much shorter duration than the marginal production of 2008 from the Gulf of Mexico. Deepwater projects can take 5-10 years to produce first oil and, when it finally comes, wells under extreme pressure miles below the seafloor produce at persistently high flow rates for project lives that can last up to 30 years. The point is that supply elasticity is likely to bite much faster this time around and, even with the production backdrop pre-shale, low prices didn’t last for long in 2009. So in this festive season, be thankful for the boost to disposable income that today’s low oil prices provide, but don’t expect them to last.

Our Takeaways from the Week

  • The U.S. continues to demonstrate its global economic leadership as blue chip stocks prepare to close out another good year
  • $60 oil prices provides a meaningful boost to U.S. consumers, but low prices are likely to prove fleeting


A Pleasant Shade of Gray


, , , , , , , , , , , ,

by Jason Norris, CFA
Executive Vice President of Research

Headline sales numbers from Black Friday looked disappointing with revenues falling 11 percent in 2014, which follows a negative year in 2013 as well. However, when we dig into the data, we see that sales have spread out over the entire week. Many stores have been starting their promotions earlier in the Thanksgiving week, meaning Black Friday is not the seminal event it once was. Coupled with an increasing amount of shoppers going online, the post-holiday shopathon is not the signal to the markets it once was.

Data from the entire weekend looked fine with sales rising approximately four percent, with a 15 percent clip coming from online sales. In forecasting the entire holiday season, industry analysts still expect low to mid-single digit growth. In light of gasoline prices down 35 percent from last year, we are comfortable with that growth forecast. In fact, this led us to increase our allocation to the consumer discretionary sector recently.

Quantitative Speaking

With the Fed wrapping up its quantitative easing last month, the European Central Bank has upped their rhetoric. This week, ECB president Mario Drahgi was more adamant that the ECB will be in the markets buying bonds. This put a small bid on the Euro; however, we are still waiting for the ECB to actually make meaningful purchases. Since 2012 when Drahgi stated the bank would do “whatever it takes” to prop up the Euro economy, there has been a lot of speaking, with little actual easing.

The economic data points coming out of Europe have been neutral at best. While the old adage of “don’t fight the Fed” may be appropriate for the ECB and European equities, we would rather focus on large cap U.S. stocks due to a strong economy, falling commodity prices and low interest rates. One potential headwind for multinationals is going to be the strength of the U.S. dollar. The dollar has rallied 10 percent the past few months and this will start effecting overseas results this quarter. Due to this, recent portfolio additions have focused on the domestic economy, rather than the global economy.

Our Takeaways for the Week: 

  • Falling gas prices and an improving U.S. economy keeps us bullish on U.S. stocks
  • Continued dollar strengthening will benefit U.S. stocks and bonds, while pressuring commodity prices, thus keeping inflation low


10 Investment Themes to be Thankful For


, , , , , , , ,

by Brad Houle, CFA
Executive Vice President

This week as we gather with friends and family to celebrate Thanksgiving we thought it appropriate to reflect upon recent investment themes for which we are thankful.

Top 10 Investment themes to be thankful for:

  1. The midterm elections are over. More important than the outcome is the fact that the elections have been decided and the markets have a reprieve from the election cycle until mid-2015. However, like Christmas displays now appearing in stores prior to Halloween, the 2016 election will start to dominate the news far sooner than it needs to.
  2. The Federal Reserve is more open and transparent than it has ever been in its history. As part of the Bernanke Fed, there was an attempt to be more open and transparent relative to communicating interest rate moves to the markets. This transparency has been continued with the Yellen Fed and has been effective in setting the expectations for investors as to the next moves of the Federal Reserve. This openness helps to mitigate the uncurtaining around Fed actions.
  3. Unemployment is at 5.8 percent. At the end of 2009 unemployment was at nearly 10 percent. While the labor market has been painfully slow to heal, the rate jobs are being added each month means we should reach theoretical full employment sometime in 2015. Theoretical full employment is thought to be around 5.4 percent unemployment, as every person of working age cannot be employed in the economy due to a variety of reasons.
  4. Oil prices have declined precipitously this year. While a decline in oil prices has been a headwind for energy stocks, it is great for U.S. consumers. When gas prices decline, it directly puts money into consumers’ pockets and should help consumer discretionary stocks.
  5. The municipal bond market has extraordinarily low default rates. Despite the recent default in Detroit and Puerto Rico’s widely publicized troubles, the municipal bond market defaults are exceedingly rare. According to Moody’s, the default rate for the entire 43 years in which the data is available is .012 percent.
  6. The Federal Reserve is expected to raise short-term interest rates sometime in 2015. This is good news because if this does indeed happen it demonstrates the strength of the U.S. economy. If the Federal Reserve is compelled to raise rates to keep the economy from overheating, it speaks volumes about the robust economic growth in the U.S.
  7. The United States has a healthy level of inflation in the economy. Inflation as measured by the Consumer Price Index is running at around 1.7 percent annually. Too much inflation in an economy is damaging, such as what was experienced in the United States in the 1970s. Conversely, too little inflation can be toxic to an economy. Deflation is when inflation turns negative and prices grind lower. This can cause a negative feedback look whereby consumers and businesses delay purchases in hope of getting lower prices
  8. The U.S. dollar is strong. It is said that money flows where it is treated best, and, with the robust U.S. economy, our dollar is appreciating against many foreign currencies. This will spur foreign investment in our financial markets.
  9. The current economic cycle shows no signs of overheating. A question we get asked frequently is how much longer does this business cycle have to go? Economic cycles die of overheating, not old age. This has been a painfully slow economic recovery that has been around for approximately 5 years. A slow growing economic expansion with no signs of a bubble in the economy has the potential to last.
  10. Corporate earnings remain strong. According to FactSet Research, of the 487 companies in the S&P 500 that have reported earnings for the third quarter of 2014, 77 percent have reported earnings above the mean estimate and 59 percent have reported sales above the mean estimate. This equated to a blended earnings growth rate of 7.9 percent for the previous year as of the end of the third quarter.