The Market: November/December 2015

The market has given investors a roller-coast ride.

The summer was sharply down with oil prices, a strong dollar, and the prospect of a Fed interest rate hike weighing on the market.

October saw a nice rebound as economic data showed that the US was performing well.

Then came November and weakness returned as oil, the dollar, and rates once again put a scare in the minds of investors.

At this point, I’m not too concerned with oil.  As it is said,

“Low prices are the cure for low prices.”

At $35 per barrel, a good deal of world production is not viable.  Rig counts are falling and at some point, supply will tighten and prices will rebound.  In the meantime, I would suggest that there are many oil companies that could be longer-term bargains.

A strong dollar

The strong dollar has been problematic for companies that sell goods outside the US. Accounting rules require that US firms state their foreign earnings in US dollars.  When the dollar is strong, the foreign earnings become a drag on profits.

The reason that the US dollar is strong relative to other currencies is that the US economy has recovered faster than the rest of the world from the 2008 financial crisis.  It is this stronger recovery that is leading the Federal Reserve to raise rates.

Fed rate hike

While not a certainty, the markets are implying a 70-80% probability that the Fed will raise rates next week by 1/4%.  This would be the first rate increase in over a decade.

It has been so long since a rate hike that the mere idea of it brings anxiety.  I don’t believe that a 25bp move in short-term rates will slow the economy.  In fact, it appears that investors are hoping for a rise, which they believe is a signal from the Fed that the economy is fine.

Continued zero rates, many would interpret as an admission by the Fed that the economy is faltering.  A Fed rate increase has been widely telegraphed to the markets and I think has largely been priced in.

Getting this, “Will they,?  Won’t they?” tug-of-war behind us is probably a positive and the market might well rally.

Bond market stresses

More important than the question of rates are some of the stresses we are seeing develop in the bond markets.

Falling oil prices are putting pressure on smaller producers that issued junk bonds to finance their fracking operations.  This, combined with worries that higher interest rates will slow the economy, has created a very nervous junk bond (high yield) market.

This part of the bond market has always been relatively illiquid and was made even more so by the Dodd-Frank rules.  When markets are nervous, reduced liquidity can lead to panics.

The Third Avenue Credit Fund announced last week that it was closing.  This is not a healthy sign for bonds.

The bond markets warrant close attention.  This week and the rest of December is likely to be volatile as the market sorts out the Fed decision.

Regardless of what the markets do, this time of the year is for giving thanks, generosity, and cheer with family and friends.

Happy Holidays!

— Ian Green, Pendragon Capital Management

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Note: This blog article is intended for general informational purposes only. Nothing in it should be construed as, and may not be used in connection with, an offer to sell, or a solicitation of an offer to buy or hold, an interest in any security or investment product.