Stocks tumble on falling oil prices & Fed rate hike fears

Money has never made man happy, nor will it. There is nothing in its nature to produce happiness. The more of it one has the more one wants. – Benjamin Franklin

In the aftermath of OPEC’s decision not to reduce oil production, the price of oil plunged last week to below $36 a barrel and stocks followed suit with steep losses in all three major stock market averages. The S&P 500 Index lost almost 4% and is now down 2.3% for the year based solely on price that excludes dividends. Including dividends, the total return for this benchmark is basically flat. Continued strength in the dollar and a forecast by the International Energy Agency that oil inventories would remain high and demand would remain weak into next year also caused the price of oil to drop. Energy stocks suffered losses and those losses carried over to the junk bond market where oil and gas related issues were hit particularly hard. One high yield bond fund, the Third Avenue Focused Credit Fund, announced that it was liquidating the fund and was forced to halt redemptions by investors to ensure an orderly sale of its bonds at reasonable prices. Prior to this announcement, energy-pipeline operator Kinder Morgan cut its dividend in an effort to conserve cash and natural resource giant Freeport-McMoRan said it would suspend its dividend, reduce copper production and revise its oil and gas capital spending plans. All of this news served to further rattle investors’ nerves and contributed to the selling pressure. To make matters worse, tax-loss selling by investors to offset any realized capital gains typically occurs this time of year and this has only exacerbated the situation. Knowing full well that the Federal Reserve almost certainly plans to raise interest rates next week for the first time in nearly a decade also weighed on investor sentiment. Although a rate hike has been telegraphed and should amount to only 25 basis points, it still creates a lot of uncertainty and angst among investors.

Last Week

If plunging oil prices, weakness in junk bonds and the prospect of higher rates weren’t enough, Chinese trade data was weak as exports in November declined for the fifth straight month and imports fell for a record thirteen straight months. This data only added to concerns about slowing global growth. The producer price index (PPI) rose 0.3% in November, higher than expected, but core PPI that excludes food and energy has risen only 0.3% over the past year. While U.S. November retail sales rose 0.2%, less than expected, core retail sales jumped 0.6%, a sign that consumer spending is strong and can support a Fed rate hike. Core retail sales exclude autos, gasoline, building materials and food services.

Dow Chemical and DuPont announced a $130 billion merger in the chemical industry and the combined corporation will eventually be split into three distinct companies for chemicals, agriculture and plastics.

For the week, the Dow Jones Industrial Average dropped 3.3% to close at 17,265 while the S&P 500 Index fell 3.8% to close at 2,012. The Nasdaq Composite Index lost 4.1% to close at 4,933.

This Week

The main attraction this week will occur on Tuesday and Wednesday as the Federal Open Market Committee (FOMC) meets to review its interest rate policy. It is widely expected that the Fed will raise the federal funds rate by 25 basis points even though the events of last week may have raised some doubt. The Fed will also give forecasts on economic growth, inflation and employment. The November consumer price index (CPI) is forecast to be flat as inflation remains benign. Housing starts for November are expected to increase as the housing sector continues to show steady improvement.

Among the most notable and familiar companies expected to report quarterly earnings this week are Oracle, FedEx, CarMax, Accenture, General Mills, Carnival and Darden Restaurants.

Portfolio Strategy

After the drubbing that the stock market took last week, it looks more and more like Santa Claus will not be visiting Wall Street this year. The total return of the S&P 500 is hovering around the flat line and most large cap stock mutual funds are performing even worse than the benchmark. Small and mid-cap stock funds have also underperformed the broad market and have posted even steeper losses for the year. Despite quantitative easing by the European Central Bank (ECB) and easy monetary policies in Japan, international developed market funds have failed to respond and returns have been disappointing as well.   The biggest losers overseas have been the emerging market funds, which have seen double-digit losses this year due to slowing economic growth, weak currencies and falling commodity prices. Even alternative asset classes such as real estate investment trusts (REITs), natural resource funds and MLPs have not provided any protection for investors. After soaring over 30% in 2014, REITs have come back down to earth and posted slight losses while commodity prices have tumbled due to weak demand and a lack of inflation. Plunging oil prices have not only torpedoed shares of energy companies but income-producing and high-yielding MLPs have also taken it on the chin. Until last week, high yield bond funds had been a relatively safe place to hide but fears that low oil prices would lead to energy company defaults caused investors to question that strategy. The bond market has confounded investors, too, and returns have been lackluster. The yield on the 10-year Treasury bond was 2.17% at the end of 2014 and on Friday, the yield on that same bond was 2.14%. With only about three weeks left in the year, unless Santa Claus has a change of heart, it looks like 2015 will wind up being a frustrating and difficult year for investors.