The last twelve months have added to a continuing gap in the outperformance of U.S. stocks versus those around the globe. Many equity analysts are now pointing to the relative value of stocks outside the U.S., due to this lagging performance and lower valuation ratios. But as the dollar continues to strengthen, the flow of dollars into U.S. equities has persisted. We will be watching for any major changes to this trend as we begin a new year. The blue bar in the graph below shows how handily U.S. stocks have outperformed the other major asset classes over the last 3 and 5 years:
Early in the month, the U.S. Congress passing an omnibus spending bill to fund the government through next September. Dubbed the "CRomnibus" bill (Continuing Resolution omnibus spending bill), so many things were inserted that it took a while to figure out what exactly was included.
When the dust settled, it turned out that a big piece of the Dodd-Frank reform aimed at reducing risk was gutted by the megabanks like JP Morgan and Citibank. Instead of reducing their derivatives exposure, Congress authorized the banks to trade "certain financial derivatives" in subsidiaries that are insured by the FDIC. That means, of course, that the banks will ramp up their trading, since any losses will be offloaded to the taxpayer, while the banks keep all the gains.
Interestingly, the Federal Reserve has been pushing in the other direction. In regulations drafted to de-risk the banking system, they would require larger "capital cushions" by megabanks to absorb the types of losses contemplated in the above "FDIC push-out" provision. The proposal will be phased in starting in 2016 and take full effect in 2019, and is aimed squarely at forcing big banks to shrink, to reduce the likelihood that a firm's failure could require bailouts or damage the broader economy. Fed Vice Chairman Stanley Fischer inadvertently let it slip this month that JP Morgan would not pass the test under the new rules. We suspect that JP Morgan is not losing too much sleep over this, given their giant victory in Congress.
Later in the month, the Federal Reserve announced a potential end to "QE" after their FOMC press release dropped its forecast that rates would stay low for a "considerable time", instead noting that it would be "patient" in judging when to start raising rates. Analysts noted that stronger U.S. economic data of late had prompted the change, and all eyes will now be on the performance of the U.S. economy for further clues about the Fed's intentions.
As if right on cue, third quarter GDP was released at month end and, at 5%, it was the strongest gain since 2003. Third quarter GDP was also revised up from an initial 3.9%, and Q2 increased to a revised 4.6%. Together with the strong jobs number in November (a gain of 321,000) and, at 5.8%, a fast falling unemployment rate, the U.S. is clearly picking up steam. It is likely that lower gas prices are boosting consumption, unlike Russia, which is highly dependent on export sales of crude oil.
Russia's economy, in fact, has taken a huge hit, which was publicly acknowledged this month by Czar Putin. Appearing on national TV, he told his country to gird for a recession that could last at least two years. The speech came against the backdrop of a ruble in free fall (see chart below), with conditions so bad that by December 16th trading was halted in all Russian stock market futures contracts. Currency traders quickly suspended market-making in US Dollar / Ruble swaps, effectively freezing up capital markets. Russia's central bank hiked short term interest rates from 10.5% to 17% to try to stem the selling of rubles, to no avail. While the situation has calmed down somewhat, it is a glimpse of the dramatic rise in volatility that can accompany markets or currencies that are "out of favor".
Source: Yahoo Finance
That's a wrap for this month. We hope you enjoyed the holidays, and are rested and ready for 2015. Thanks for reading our Journal, and we'll be back to you in early February with our next installment.