S&P 500 closes lower, ends year in red as oil prices slide

Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well. – Warren Buffett

In a fitting end to what could be described as a difficult and frustrating year for investors, the S&P 500 Index closed down almost 1% last week in quiet trading. For the year, this benchmark declined 0.8% while the Dow Jones Industrial Average fell 0.7% last week and lost 2.2% for the year. The lone bright spot was the technology-laden Nasdaq Composite Index, which also finished lower in the holiday-shortened week but was up 5.7% for the year. After posting three consecutive years of double-digit gains, the S&P 500 Index finally ran out of steam and registered its first losing year since 2008. While the week between Christmas Eve and New Year’s Eve had been favorable to stocks on an average return basis since 2000, this past week proved to be the exception as stocks followed oil prices lower. The price of oil dropped to $37.10 a barrel at year-end, down 3% for the week and over 30% for the year. This precipitous decline has not only affected stocks in the energy sector but the overall market as well. Reports that U.S. crude oil inventories were up last week along with confirmation that Saudi Arabia plans to produce more oil to maintain its market share were the main catalysts behind the drop in oil prices. With sanctions probably being lifted in the first quarter, Iran will also be producing oil to sell in world markets. In addition to weak oil prices, commodity prices in general have also been declining and that, coupled with slowing global growth and uncertainty over corporate earnings, has made investors cautious about the prospects for 2016. Economic data last week only seemed to muddy the waters even more and left investors confused as to whether or not the economy was gaining strength. With fourth quarter earnings season less than two weeks away, investors won’t have to wait much longer for an answer.

Last Week

The S&P/Case-Shiller National Home Price Index showed that home prices rose 5.2% in October as low mortgage rates and low inventories of homes caused prices to increase. Pending home sales in November fell slightly but came in almost 3% higher than a year ago. Low levels of supply have driven housing prices higher and have made homes unaffordable for many prospective buyers. According to the Conference Board, consumer confidence soared in December due to a positive outlook for the job market.

Not all of the economic news last week was positive as the Chicago Purchasing Managers Index (PMI) fell sharply and weekly jobless claims spiked by 20,000 to 287,000, though the holiday season can cause the numbers to be volatile.

For the week, the Dow Jones Industrial Average fell 0.7% to close at 17,425 while the S&P 500 Index lost 0.8% to close at 2,043. The Nasdaq Composite Index declined 0.8% to close at 5,007.

This Week

Construction spending in November is expected to be about half the number reported in October while factory orders in November should be little changed in keeping with flat durable goods orders for the month. The employment report for December is expected to show that 200,000 new jobs were created and that the unemployment rate remains at 5%.

On Wednesday, the minutes from the most recent Federal Open Market Committee (FOMC) meeting will be released and they should provide insights on why the Fed agreed to raise interest rates last month as well as give possible clues about future monetary policy moves.

It will be a relatively quiet week on the earnings front as the most prominent companies scheduled to report include Supervalu, Bed Bath & Beyond, Constellation Brands, Walgreens Boots Alliance and Monsanto.

Portfolio Strategy

Oil wasn’t the only commodity that saw its price plunge during 2015 as the price of gold also declined nearly 11% and ended the year close to a six-year low. Since reaching a record high in 2011, gold has fallen almost 43% and the pain may not be over for the precious metal. There continue to be a number of headwinds for gold, not the least of which is weak global economic growth, particularly in China where demand for gold and other commodities has dropped. The fact that the Federal Reserve has begun to normalize monetary policy by raising interest rates could also prove to be problematic for gold. If the Fed is forced to raise rates faster than expected, that could weigh on the price of gold as it pays no dividend and has difficulty competing with any investments that do. Global inflation is also expected to remain muted, which makes holding gold less attractive to investors. There are certain scenarios, however, that could make gold a worthwhile holding. Weaker than forecast U.S. economic growth combined with slower than expected Fed tightening could boost the prospects for gold. Prices could also rise if inflation begins to accelerate or the stock market suffers a huge decline and investors seek a safe haven. During times of geopolitical tensions and economic uncertainty, gold tends to hold its value and perform better than other assets. While the prospects for gold and other commodities do not appear to be any better for 2016, this asset class is not correlated with equities and can act as a portfolio diversifier by reducing overall risk. Any allocation to gold and other commodities should be limited to less than 5% of an investment portfolio, with a 2% or 3% weighting a reasonable strategic target.