US en­ters 2015 on strong note

Enterprise - - Contents -

Strong growth, cheap en­ergy and some forced gen­eros­ity from the Fed­eral Re­serve due to fall­ing in­fla­tion, all im­ply a strong first half of 2015 for US fi­nan­cial mar­kets.

That the rest of the world, China, Ja­pan and Europe will all see weak­ness will only re­in­force the at­trac­tion of dol­lar as­sets, which will ben­e­fit par­tic­u­larly from the easy mon­e­tary con­di­tions.

The risk is that pol­i­cy­mak­ers and in­vestors un­der­es­ti­mate US eco­nomic strength, set­ting the stage for an eq­uity mar­ket down­draft if the Fed is forced to raise in­ter­est rates sooner than an­tic­i­pated.

It has been a time of gifts for the United States, with the econ­omy ex­pand­ing at a 5 per­cent clip in the third quar­ter, the best show­ing since 2003. Par­tic­u­larly en­cour­ag­ing was the nearly 9 per­cent ex­pan­sion in business in­vest­ment, a sign that cor­po­ra­tions are en­cour­aged about prospects.

Con­sumer spend­ing grew, too, and should con­tinue to ex­pand given the ef­fect on wallets of the quite rapid fall in the price of oil - down nearly 50 per­cent on some mea­sures since June. The ef­fect of cheaper en­ergy is be­ing felt more pow­er­fully now than in the third quar­ter and will be more pow­er­ful yet in 2015.

That helps to ex­plain why US stocks are trad­ing very near their all­time highs in in­fla­tion-ad­justed terms, as does the stance of the Fed­eral Re­serve, whose pro­jec­tions and over­all mes­sage after its last rate­set­ting meet­ing in De­cem­ber were far more down­beat than the data re­leased since then.

The fall in oil prices could drive core in­fla­tion, al­ready well be­low Fed tar­gets, lower yet. That could con­vince a Fed­eral Open Mar­ket Com­mit­tee, which will have a more dovish lineup in 2015, to wait longer be­fore rais­ing rates.

“A zero per­cent rate pol­icy in the face of the lat­est 6 per­cent trend in nom­i­nal gross do­mes­tic prod­uct is likely a case of play­ing with fire for even the most dovish Fed in re­cent mem­ory,” David Rosenberg, strate­gist at Gluskin, Sh­eff in Toronto, wrote in a note to clients.

In­vestors in eq­ui­ties are gen­er­ally thrilled when pol­i­cy­mak­ers take risks with over-heat­ing, though they are of­ten not so happy once the cor­rec­tive steps are taken. All of this ar­gues for a con­tin­ued rise in the dol­lar in the early stages of 2015, and strong rel­a­tive per­for­mance from riskier US as­sets like eq­ui­ties and higher-yield­ing debt.

As a mar­ket phe­nom­e­non, all of this is self-sus­tain­ing. Good data, good prof­its and easy mon­e­tary pol­icy drive gains in the stock mar­ket, which in turn forces less-con­vinced in­vestors from the side­lines.

The im­pact from cheaper en­ergy is strong and will get stronger. US growth will be as much as 0.5 per­cent­age point higher than oth­er­wise, ac­cord­ing to the In­ter­na­tional Mon­e­tary Fund, and as much as 0.6 per­cent­age point in 2016. To look for a his­tor­i­cal par­al­lel, oil prices fell even more sharply in 1985 and 1986, set­ting the stage for a multi-year eco­nomic ex­pan­sion.

“As is the case now, most an­a­lysts were un­der­es­ti­mat­ing how well the econ­omy was go­ing to do as 1986 drew to a close - that 1987 was go­ing to be a real break­out year for growth, bond yields, the Fed, and stock mar­ket vo­latil­ity,” Rosenberg wrote. It is, of course, im­pos­si­ble to fore­see a ma­jor mar­ket cor­rec­tion. But a sce­nario in which the Fed hikes sooner than ex­pected next year, and gives off signs it will raise rates more rapidly than an­tic­i­pated, is one that would also fig­ure a great deal of down­ward vo­latil­ity.

This is not the only way it could play out. The Fed may well be jus­ti­fied in wait­ing, or it could eas­ily bring the mar­ket along with it as it edges to­ward hikes in the first three months of 2015.

The price of oil could also be telling us that things glob­ally are weak enough to jus­tify a longer de­lay in pol­icy nor­mal­iza­tion by the Fed.

Much of the fall in oil prices is due to plen­ti­ful sup­ply, both as a re­sult of the ap­pli­ca­tion of new tech­nol­ogy in the United States and older sup­pli­ers like Libya com­ing back on­line after po­lit­i­cal dis­lo­ca­tion. The IMF, how­ever, es­ti­mates that 20-35 per­cent of the fall is due to de­creas­ing de­mand, which is a warn­ing sig­nal.

Cop­per, a base metal used heav­ily in in­dus­try and which of­ten moves in tan­dem with global growth, re­cently touched four-and-a-half-year lows and was down about 18 per­cent. That may fore­shadow weaker con­di­tions in Europe and China, which could hurt US growth and out­weigh the ben­e­fit of cheaper oil.

Mean­while, the party in US risky as­sets looks set to con­tinue, and with few good al­ter­na­tive choices else­where, in­vestors, as ever, will be forced to pile in.

Newspapers in English

Newspapers from Pakistan

© PressReader. All rights reserved.