Market Perspective for December 19, 2014

It has certainly been a volatile week for the financial markets, but domestic stocks appear to have regained their momentum following the Federal Reserve policy statement on Wednesday.

The wildest day of the week overseas was Tuesday, when the Russian ruble collapsed to 80 per U.S. dollar. In the days since, the Russian central bank has taken bold stops to halt the slide, including an interest rate hike to 17.5 percent. As the week closes, the ruble has stabilized below 60 per U.S. dollar. At the same time, oil prices are finding support in the mid-$50 range. Many emerging markets were also hit by the drop in the ruble. In China, two automaker stocks plunged nearly 50 percent on rumors that losses in Russia would hurt their companies.

Some domestic oil producers are dialing back investments in response to low prices, including reports of layoffs in Texas. Still, as Bloomberg reported, U.S. oil production is set to increase in 2015 due to the falling cost of production. Once the wells are drilled, the ongoing costs related to pumping oil are well below the current market price. It will be time and even lower prices for U.S. production to decline. With the Saudis pledging to defend their market share, the world may have an oversupply of oil well into the first half of 2015.

In addition to low oil prices continuing into 2015, stocks received good news from the central bank. The Federal Reserve signaled higher interest rates are coming in 2015 by dropping its “considerable time” language. Formerly, the Fed said rates would stay low for an indefinite period of time. This week, they changed both parts of this policy. The first part was interest rate hikes are expected in 2015, but the second part was that the Fed will be “patient.” At the press conference after the meeting, Fed Chair Janet Yellen said patience meant waiting at least two meetings before hiking rates. Based on the schedule, that means no rate hikes until the March meeting at the earliest.

The gist of the Fed statement is that the economy could probably handle interest rate increases now, but since risk factors including inflation are not a threat, the Fed can afford to wait until conditions are even stronger.

It may all come down to oil prices in the end. The stronger economy is pushing prices up, but the plunge in oil prices has completely counteracted this trend and we may see some deflation over the short-term. As the economy strengthens and credit expands, prices will naturally push higher, though cheap oil will act as a moderator. Unless the economy starts booming, the Fed will probably take advantage of the opportunity, provided by low oil prices, to hold rates down a little longer than expected.

Naturally, investors like the sound of a growing economy and low interest rates. Investors responded to the Fed’s statement by bidding up stocks on Wednesday and Thursday, leaving the S&P 500 Index in striking distance of its all-time high. The small cap Russell 2000 pushed to its highest level in two months.

Investors signaled they don’t expect rate hikes to come too soon because stocks in the financial sector didn’t lead the market higher. Nevertheless, the sector remains attractive given the economic and interest rate outlook heading into 2015.

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