December 27, 2014 Predictable

Risk/Reward Vol. 247

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

"So you don't have to call
Or say anything at all
You're so predictable."---lyrics from "Predictable" sung by Good Charlotte

"Let it grow/Let it grow
Let it blossom/Let it flow."---lyrics from "Let It Grow" sung by Eric Clapton

"Cover you in oil/Let me cover you in oil
I wanna cover you in oil/Cover you in oil."---lyrics from "Cover You In Oil" sung by AC/DC

I take one week off and WOW. Talk about a Santa Claus Rally! The spectacular two week performance began with Janet Yellen's press conference on December 17th. Since the market's close on December 16th, the Dow Jones Industrial Average (DJIA) has gained nearly 1000 points or 5.8%, a percentage increase mirrored by the S&P 500! Why you ask? The answer lies in the road map for interest rates that Chair Yellen outlined. Indeed, when it comes to rates, "you don't have to call/Or say anything at all. It's now so preditable" Here is what will happen. No rate increase will occur for at least two meetings (read June, 2015) and the increase(s) thereafter will be slight and gradual. So let's see: with historic low interest rates continuing and with China, Japan, Europe, Russia and the emerging markets in the tank, where can one get ANY return on one's money? Duh---there is only one place: US equites, assuming, of course, our economy continues to grow.

And continue to grow, it does. On Tuesday, the Commerce Department issued revised gross domestic product numbers showing the US economy grew in the Third Quarter at an annualized rate of 5%, the highest rate of growth in over a decade. That number blew the doors off market expectations. "Let it grow/Let it grow/Let it blossom/Let it flow." Indeed, GDP growth was so stunning one would have expected interest rates to sky rocket in anticipation of a sooner-rather-than-later tightening of monetary policy (the fear of which in recent years has caused equity markets to drop)---had not the Fed laid out its course of action just the week before. The rate on the bellwether 10 Year US Treasury Bond did rise to 2.25% by week's end, but this is well within its several month trading range. Indeed, securities tied to the 10Year rate (e.g. municipal bonds, preferred shares, real estate investment trusts, utility stocks) held steady all week, once again compliments of a clearly articulated monetary policy. Another factor keeping longer term US rates low is the spread between the two most stable debt issuing countries in the world---Germany and the US. The German 10Year Bund carries a rate below 0.6% compared to 2.25% on the US 10 Year a spread of nearly 1.7%--an historic high. As stated in the last edition ( Vol. 246 www.riskrewardblog.blogspot.com ) given a choice why would one buy a Bund and not a US 10Year? So again, with interest rates low, the US economy growing and the rest of the world in the tank, US equities are the best game in town.

Contributing to the good news is the incredible drop in the price of oil and natural gas. AAA estimates that with oil at $55/bbl. and gasoline nearing $2/gallon at the pump US disposable income could increase as much as 3 1/2% over last year. This should result in a big bump in consumer spending. From an investment perspective, one should not expect a turnaround in oil prices any time soon. The Saudi Oil Minister announced this week that OPEC will not reduce production even if the price of oil falls to $20/bbl. Clearly, Saudi Arabia sees the drop in prices as an opportunity to reduce competition from higher priced producers such as Russia, Nigeria, offshore drillers and the frackers here in the US. That said, the world runs on oil, and oil is a depleting asset. Someday the price will stabilize and start to rise. Those who have the stomach to invest in it will be rewarded handsomely. "I don't wanna cover you in oil/Don't let me cover you in oil"---not yet at least. But initiating a quarter or a half position in any established oil company at current price levels makes a great deal of sense. CVX, ETP and COP are recovering nicely, and KMI barely dipped at all. I bought some of each recently. However, holding one's powder on more speculative oil plays until a turnaround is confirmed seems prudent at this time.

Two weeks ago, the DJIA was languishing, up just 2% for the year. But thanks to Janet Yellen, the Dow shot "Back Into the Black" like it was "Thunderstruck." It was not such a "Long Way to the Top" after all. All it took was some unambiguous policy guidance from the Fed Chair. As AC/DC puts it:

"She's got style, that woman
Makes me smile, that woman
She's got balls."
(Think not? Check the accompanying photo)