Quarterly Investment Outlook: January 2016

SUMMARY

• The Fed is determined to increase the Fed funds rate on 12/16.  We are concerned that they could be making a policy mistake.  The expectation of the first rate increase in nine years has pushed up the value of the U.S. dollar 19% over the past eighteen months.  Depressed inflation expectations could pressure the Fed to pursue a shallower rate path into 2016.
• A rising dollar over the past eighteen months is the equivalent of de facto Fed tightening of financial conditions by an estimated 200 basis points worth of rate increases.
• Slowing new orders for capital goods, coupled with tepid growth in credit is signaling economic growth may be decelerating.  Both the GDPNOW model and Economic Surprise Index are decelerating.
• The stock market expects earnings growth of 8% in 2016.  This may prove too optimistic unless the U.S. dollar corrects.
• Maintain a defensive investment strategy favoring bonds over stocks and foreign equities vis a vis domestic.
• Commodities are in a secular bear market, but the dollar could correct and decline subsequent to the Fed raising rates, which would give commodities a cyclical boost.  Watch Saudi oil production for signs the Kingdom wants higher prices.

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