The US economy is flourishing in a floundering global economic environment. I heard this comment today from Zacks Investment Research. I think it very accurately describes the present outlook.
As I indicated in my November 2014 Monthly Outlook, the month of November was much calmer in the equity markets. There were 19 trading days during the month, and only 1 day (11/5/14) saw a change greater than 0.5% move in either direction. For the month the equity market increased 2.45% basis S&P 500 (source: Yahoo finance)
However, the same was not true in the bond (fixed income) markets. For November 2014, the US 10yr Treasury declined from 2.34% to 2.19% – a drop of 6.41% – with 8 trading days having greater than 1% moves up or down. (source: Yahoo finance)
A number of factors led to the volatility in the bond markets and the decline in interest rates:
- Oil prices have been on a steady decline. Energy is a big component of inflation so declining energy costs mean inflation will decline from an already low level. Generally low inflation leads to lower interest rates.
- Globally government bond interest rates have been declining, to levels where US Treasury interest rates are higher, thus drawing money into Treasuries. As example, the German 10yr Bund rate is only 0.73%. (source: Bloomberg 12-2-14) Remember that as money flows into bonds it drives the price of bonds up, which drives interest rates down.
So what are the effects of lower oil prices and lower interest rates?
Positive effects:
#1 – Consumers benefit from lower energy costs and these savings can be put towards investments or, more likely, spending.
#2 – the housing market benefits from lower interest rates, which should continue to support the recovery in US housing as well as reducing consumer debt burden via refinancing. (30 yr fixed rate mortgages have dipped back below 4%)
#3 – countries that import their oil – including Japan, China, India and most of Europe – will get a boost to their economies that they surely need.
Negative effects:
- The US energy sector will see some declines. This will affect both oil producers, like Exxon Mobil, as well as companies that provide equipment and services to the energy industry.
- High cost energy producing nations, such as Canada, Russia and Iran, will see their national revenues decline due to falling oil prices, which will hurt their economic growth.
- The low level of inflation globally is worrisome as the potential for deflation increases. See chart below for the potential negative effect of deflation.
source: Investinganswers.com
In summary, on balance the decline in energy costs and low interest rates should provide a net stimulus to global economic growth, provided deflation is avoided. I anticipate that the decline in oil and interest rates may lead to some short-term volatility in the equity markets but any decline will be minimal and the S&P 500 should finish in the 2,050 area. I am managing your portfolio accordingly.
December Calendar of Events (comments and additions for future months are always welcome)
- December is Universal Human Rights Month. Let’s all be grateful for the freedoms we have as Americans and pray for those less fortunate.
December 7th Last day to enroll or make changes for Medicare Parts B, C and D
December 16th First day of Hanukkah
December 21st Winter Solstice – shortest day of the year
December 25th Christmas
Best wishes for a wonderful Holiday season to you and your family.
Sources: International Strategy & Investment, Yahoo Finance
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