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A Mixed Bag

| December 19, 2016
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Some may think with Christmas coming near, that this week’s title refers to what Santa has in store for you. Instead, it leads us into our weekly discussion on the financial markets. We’ll leave it to you and Santa to hash out the rest.

Major domestic equity market indexes were decidedly undecided last week. The widely-followed large-cap S&P 500 Index was essentially flat, while smaller company indexes, which have outperformed substantially for the year as a whole, gave up ground. So-called “Growth” category technology stocks regained some traction at midweek, but “Value” category stocks maintained their substantial lead over growth shares in the post-election rally.

Energy shares led the way early in the week. Over the prior weekend, several non-OPEC oil producers agreed to a series of cuts, while (in a surprise) lead OPEC producer Saudi Arabia implied that it would scale back its own production even more than its recent commitments. Oil prices jumped Monday morning but then fell back later in the week, partly due to a rising U.S. dollar. The reason? Oil is priced in dollars, and a rise in the currency typically threatens demand for the commodity. Rising US oil inventories also weighed on prices. Many experts continue to believe that technological advances and falling costs for shale production will keep a lid on oil prices over the longer term.

Wednesday brought the long-awaited foregone conclusion from the Federal Reserve, and equity shares gave up their gains in reaction to the Fed’s two-day policy meeting that ended midweek. While the Fed’s decision to raise rates for only the second time in a decade was widely anticipated, investors appeared to react negatively to the news that most policymakers now expect three rate hikes in 2017, instead of the two predicted in September. The market’s consternation came in the realization that the faster pace of rate hikes may reflect that the labor market is closer to the FOMC’s objectives than had been previously anticipated, and conveys more confidence that inflation will return to 2% over the Fed’s forecast horizon.

The Fed’s announcement sent a strong hawkish signal to the bond market and sparked an increase in longer-term Treasury yields. Following the meeting, the yield on the 10-year Treasury note closed at 2.58%, its highest level since September 2014 (Note that bond prices and yields move in opposite directions). The Fed’s decision to raise interest rates reverberated around the world, triggering a decline of more than 1% in an index of major emerging markets currencies, according to J.P. Morgan data. The move was the largest daily drop in over a month, demonstrating that higher rates in the US are making the US dollar more attractive against a range of currencies.

There was a bit of drama across the pond last week, as tensions surrounding continued Brexit negotiation efforts were noticeable at the European Union (EU) leader summit. While UK Prime Minister Theresa May told EU leaders that she wants to reach an agreement quickly on the status of British ex-pats living in the EU, an EU government minister reportedly told media outlet Sky News that leaders would first seek payment for a £50 billion settlement bill for outstanding liabilities before other issues are settled.

Finally, Japanese stocks posted another gain for the sixth consecutive week, helping most of the market benchmarks climb back into positive territory for the year to date.  While the weakening yen has hurt returns for dollar-based investors, it has also made Japanese companies as a group much more profitable. If the yen can continue to stabilize, odds are high that return on equity for Japan will improve in 2017. 

By the time this newsletter next reaches you, Christmas will have passed and Hanukkah will have commenced. With that, we wish you and yours the absolute best in this holiday season. We all have a tremendous amount to be grateful for as we gather with friends and family, and as we look towards the New Year ahead.

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