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!