Aaron Schaefer

Jan 05 2015

January’s Economy and Market from Here… at Hills

Economy and Market Here at Hills

Stock prices in the U.S. continued their climb to record highs during the quarter, but not without volatility. In early October, the S&P 500 Index experienced its second correction of 5% or more this year, nearly reaching 10% in intraday trading. This sell-off was short-lived and the index rebounded sharply by more than 11% by early December. Some of that was retraced by month-end, but domestic stocks ended the year in positive territory. The S&P 500 returned 13.7%, the third consecutive year of double-digit results. Much of this continued strength was due to better than expected corporate earnings, improving consumer sentiment and dramatically lower oil prices.

International stocks did not fare as well as Europe and Japan grapple with difficult economic conditions. The MSCI EAFE Index, a common international benchmark, declined 4.2% in 2014.

The rapid decline in the price of oil was the main headline during the quarter. A barrel of West Texas Intermediate Crude cost $53 at year-end, down from $107 in late June –a 50% decrease. Improved extraction technology has led to a proliferation of new wells, as well as old wells coming back online in North Dakota, Texas and elsewhere increasing domestic supply. This increased extraction, accompanied by decreased demand from slowing economic growth in Europe and China and a recent OPEC announcement that current production levels by member countries will remain the same, has accelerated the price decline.

Interest rates have also continued to decline during the quarter. The yield on the 10 Year Treasury dropped from 2.40% on September 30 to 2.21% on December 31. Despite low long-term rates, there is not a notable increase in lending, which means interest rates could continue to remain low. Much of the decline in rates is driven by factors outside the United States. Whereas the Fed has ended their Quantitative Easing program, Europe and Japan are just beginning to embark on their own extraordinary stimulus measures to revive growth in their regions.

It is our view that the global economic recovery is a work in progress. The expansion in North America seems to be well-established. Equity markets in the U.S. and Canada reflect this relative economic strength. While the Fed is moving toward a normalization of monetary policy with an end to quantitative easing, we expect a cautious approach when it comes to raising interest rates. As long as inflation pressures remain subdued, the Fed will likely focus on boosting employment and economic growth.

Lower oil prices will have a positive impact on the consumer and manufacturer alike. This should translate into increased spending and greater profits. There will be pockets of disruption in oil producing regions as weaker operators shut down. Other risks to lower oil prices include increased political unrest in Russia and the Middle East.

We expect U.S. equities to continue their upward trek, although that advance may become more sedate compared to the past three years. Equity prices should advance more in line with profits. In other words, stock multiples should hold steady or perhaps shrink slightly even as profit growth accelerates on the back of an improving economy.

The fourth quarter has seen volatility return to normal levels after a long period of calm. We believe this trend will continue heading into 2015. For investors, a key to riding out the natural volatility inherent in the stock market is to have a portfolio with a carefully constructed asset allocation. If you have not been in for an account review in some time, please give us a call. It is always good to get together to discuss strategy and to confirm that your asset mix is in line with your expectations.

Some trust products and IRA contributions/balances are not a deposit, not FDIC insured by any federal government agency, not guaranteed by the bank and may go down in value.
Aaron Schaefer

About Aaron Schaefer

Aaron Schaefer is Vice President, Trust Investment Officer at Hills Bank’s North Liberty location on Forevergreen Road. He has been at Hills Bank since 2004 and manages the investment area of the Trust and Wealth Management division. Aaron can be reached at aaron_schaefer@hillsbank.com.

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