After several years of holding interest rates near zero, the Federal Reserve commenced liftoff with a 25 basis point rate hike during its December meeting. We continue to believe that an increase in rates from such low levels need not negatively impact stocks, and in that regard were encouraged that the market reacted well to the news. The FOMC (Federal Open Market Committee) continued to stress its expectation that the pace of increases will be gradual. Moreover, during the Q&A Fed Chair Yellen intimated that it will likely be quite some time before the Fed stops reinvesting the proceeds of maturing bonds that it holds on its balance sheet. We therefore took this meeting to be dovish on balance despite the increase in rates, and we continue to view monetary policy as being firmly accommodative, particularly compared with prior interest rate cycles.
The ECB also took material policy actions during the quarter by expanding the duration of its quantitative easing program and lowering the deposit rate further into negative territory. These steps were intended to help spur economic growth and inflation. Expectations were quite high however, and European stocks sold off on the news. We believe that many investors were looking for an increase in the amount of monthly asset purchases, in addition to the expansion of the length of the program. That being said, despite the initial negative reaction, we believe this was simply a case of outsized expectations and do not see it as a lasting headwind for stocks. On the contrary, we view the global monetary policy environment as being supportive of equities.
China was again a focal point for investors during the quarter. Its economic slowdown has had significant repercussions across multiple asset classes. We believe that reduced demand out of China has played a large role in the sharp declines in oil and other commodities, which in turn have roiled segments of the junk bond market. Moreover, at times the country’s policy responses have been opaque and resulted in heightened volatility of its stock market, likely the opposite of what was intended. In early January the PBOC (People’s Bank of China) opted not to renew an approximate $20 billion credit line to the China Development Bank, only to do an about face and inject a similar amount of liquidity into its financial system the next day. Similarly, on January 4th Chinese regulators introduced circuit breakers for the Shanghai equity market, and just days later suspended the initiative. There has also been a lack of clarity pertaining to the fate of a temporary stock sale ban which was implemented last July and set to expire on January 8th. Only in the days leading up to this potential expiration date did details emerge that shareholders subject to the ban would continue to see sale limits for an additional three months. Finally, the PBOC’s push to devalue the yuan has led to renewed fears about the underlying state of the economy, as well as the possibility that the initiative will lead to mutually destructive currency wars between China and its competitor nations in the export markets.
As we look forward we see several headwinds which keep us from taking a bullish stance on the market. We view China’s economic slowdown and its questionable policy responses as the primary risks for equities currently. Given the country’s growing importance to the global economy, it is possible that these issues may continue to impact U.S. capital markets, and we have therefore taken the aforementioned portfolio actions in order to help hedge these risks. Domestically, we are also keeping a close eye on the junk bond market, which weakened considerably in December. Widening bond spreads are often indicative of investor concerns pertaining to future economic activity. This can result in a negative feedback cycle should elevated borrowing costs curtail business investment and consumer spending. We think that stocks may also be vulnerable to political rhetoric from presidential candidates who seek to impose more stringent regulations on the finance and health care industries. These initiatives, if enacted, would likely lead to reduced profits for the companies impacted by them. Lastly, we see the current geopolitical environment as a potential threat to global capital markets, and are keeping a watchful eye on escalating tensions between Saudi Arabia and Iran.
Yet there are reasons for optimism. The labor market continues to firm, and a reduced unemployment rate may help to spur wages and consumption. Though still soft by historical standards, we believe that GDP can continue to expand in the low single digit range that has persisted over the last several years. In our view, this should enable continued, albeit perhaps modest, growth in corporate earnings in 2016. Moreover, we believe that many companies have adapted well to a slower top line environment by finding growth opportunities which are not dependent on strong macro conditions. For example, following a record year for mergers and acquisitions, numerous companies have significant cost cutting opportunities which we expect to help boost profits for years to come. Finally, irrespective of the Fed embarking on its rate hike campaign, we continue to view monetary policy, both domestic and abroad, as being quite dovish, and we have a healthy respect for the influence that central banks can have on capital markets and stock prices. Overall our outlook for the year ahead is balanced. We expect modest market appreciation punctuated by bouts of volatility, as investors evaluate the various risks to global growth and ultimately price them into the capital markets.
This information is intended solely to report on investment strategies and opportunities identified by Roosevelt. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. References to specific securities and their issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Please contact us at 646-452-6700 if there is any change in your financial situation, needs, goals or objectives, or if you wish to initiate any restrictions on the management of the account or modify existing restrictions, or if you would like to request a copy of our Code of Ethics. Our current disclosure statement is set forth on our Form ADV Part II, available for your review upon request, and on our website, www.rooseveltinvestments.com.