This year has gotten off to an onerous beginning with the US market being dragged down almost 6 percent to begin 2016. 

It brings me back to some misspent days of my youth at the racetrack. We had the opportunity to see this behemoth of a horse Secretariat strutting around the track. He was a big beautiful muscular beast. We just knew he was our horse and we all ran for the window to place our bets, to show of course (which is 3^rd place or better).We didn’t have much money so we had to play it safe. Lucky for us we played it closed to the vest. For on that day he got trapped on the rail and even though he thundered down the final stretch he couldn’t make up the lost time and came in second beaten by a horse named Onion. While disappointed we all came out winners which meant a delicious bowl of clam chowder for us all once we cashed in. 

That’s where we are currently in this market. The market broke out of the gates poorly. There’s some congestion impeding our path starting with the sell-off in China’s markets coupled with light volume. But, as you all are aware investing is not a sprint and we haven’t even reached the first turn.  The economy remains in good, not great, mode. Job creation is still solid. Consumer spending and confidence are both gaining while low energy prices will provide trail winds that will remain supportive.So, let’s look at where we are. 

GDP-Fourth quarter GDP will be released later on this month.Estimates are for a one and a half to two percent gain. If this pans out we’ll have booked another not so great year for the expansion.The primary drags on growth were front and center: energy, mining,inventories and cuts to government spending (the last doesn’t appear to be a bad thing). The new budget just inked in D.C. has put to rest further fears (by some) of austerity and responsible spending of our tax dollars. That should allay fears of continued drag from cuts to government spending and possibly add ½% to 5/8% to GDP growth going forward. As well, the draw down on inventories bodes well as companies will need to restock those shelves in the coming quarters. We’d anticipate a continuation of this good not great environment and look for 2016 GDP to fall within a range of 2 1/2% -3%. 

JOBS-Job creation remains on a solid footing adding 252,000 jobs in November followed by December's whopper of +292,000.   The participation rate ticked up +.1 and the unemployment rate stayed steady at 5%. Hourly earnings along with the workweek remained largely unchanged.  The big gains were seen in good paying jobs such as professional and business services adding 73,000. Construction add 45,000 and healthcare tallied a 39,000 gain. The argument that the jobs created are all of low quality, is slowly being put to rest. This is good news going forward as well. 

Leading Economic Indicators (LEI)-LEI for November was up +.4% following October’s +.6%. Strength was noted in building permits and interest spreads. The rate of growth has moderated some though this data point suggests a positive outlook for this just completed fourth quarter and into the new year. This would also lead investors to dismiss rumors or arguments for an imminent recession for the US. 

ISM Manufacturing Index (ISMM)-ISMM dropped -.4% to 48.2 in December from November’s 48.6%. A reading below 50 reflects a contraction in the sector. The hit to the ISMM index came from the obvious sectors, energy and commodities. The new orders index was a rare bright spot rising slightly to 49.2% while the employment index dropped -3.2% to 48.1%.The only saving grace domestically lies in the fact the US economy is not overly reliant on the manufacturing sector to drive growth along with the drag on the sector from lower energy and mining. 

ISM Non-Manufacturing Index (ISMNM)- ISMNM December shaved off -.6% from November’s +55.9% to +55.3%.This continues to reflect an expanding services sector in the US but at a slightly slower pace.There were many areas of strength.The New Orders Index added +.7% to +58.2%.The Employment Index also posted a +.7% to +55.7% with prices dropping -.6%. Respondents were generally rather positive. Management Companies and Support Services stated “Business continues to be strong for consulting services”.  Construction said “Professional and skilled labor remains hard to find”. Professional, Scientific and Technical Services said “ We see continue spend demand higher than any months of this year.However productivity reaches its peak and projects need to be carried over to 2016”. Educational Services “ Construction continues at a record pace”.   The headline figure along with the commentary continue to paint a very positive picture for demand and growth heading into 2016. 

Housing-Housing remains mired in a conundrum. Even with the recovery in home prices many would be sellers remain underwater thus limiting the supply of existing homes for sale. This lack of supply is allowing sellers to demand higher pricing. Coupling this dynamic with many “newbie” or first time home buyers strapped with onerous student debt they are being either priced out of the market or unable to gain access to credit. This would partially explain the good not robust recovery in housing. Another hindrance to adding to new supply is builders are having difficulty finding skilled workers (see above ISMNM). During the housing bust many craftsmen left the industry and simply haven’t returned. 

Inflation-With commodities in near free fall for the prior eighteen months and little signs of stabilization currently, the ability for the Central Bankers to stimulate inflation has turned into a herculean task.The wildcard here is actually quite obvious. If commodities prices simply are able to stabilize the US and EU Central Banks 2% target rate would seem easily attainable.  We’re seeing upward pricing pressures from rents, home prices, auto pricing, medical care, education and to a lesser extent wages. If pricing for energy, food stocks and metals simply stopped falling through the floor we would be more concerned about inflation, but current pricing action isn’t supportive of this just yet. Fed Chair Yellen alluded to this in her testimony to Congress in 2015. 

Where are we going;

As we begin 2016 there are considerable risks, both known and unknown.

Black Condors:

1.     China aggressively devalues the Yuan. China’s transition from one driven primarily by manufacturing and export to one similar to the US reliant on services and domestic consumption is happening just not quickly enough to the latter to offset the slowdown in manufacturing and exports. The manufacturing and construction build out over the last few decades have led to vast overcapacity and enormous debt loads. In order to prop up manufacturing the Peoples Bank of China may aggressively devalue the Yuan triggering a race to debase of trading partners' respective currencies in order to remain competitive. A cheaper currency would in effect make goods manufactured for export cheaper for China giving them a decisive edge. This could set off a catastrophic set of events from massive emerging market currency devaluations stifling the somewhat fragile global recovery. 

2.     Russia retaliates against Turkey’s downing of one of their jet fighters. As the US retreats from being the sheriff of the Middle East, choosing to lead from behind, Russia looks to expand their sphere of influence, further strengthen their ties with Iran and Syria while forcing NATO to defend an ally against an aggressor setting off a firestorm and direct confrontation between the US and NATO v Russia. 

3.     Brazil ousts Rousseff setting off a set of events that further paralyzes growth potentially forcing Brazil’s oil giant Petrobras (PBR) into default.That’s over $120 billion in debt and $90 billion in dollar denominated debt. That would be a tough pill to swallow. Petrobras is caught in a corruption, graft and kickback scandal whose web has snared prominent business leaders and politicians alike. The investigation is ongoing and still playing out. Petrobras plays a huge part in Brazil’s economy and the global energy markets overall. As it stands Petrobras debt has been downgraded, projects have been put on hold and investor confidence is non-existent.This is one to watch as revenues from Petrobras fund social programs, subsidize and allow for cheap below market energy prices that keep the populace content. Take that away and watch out. 

The markets are currently caught between major crosswinds. China’s economy is slowing more rapidly than planned for causing capital flight and a policy response to devalue the local currency the Yuan. The strength in the US dollar in turn is helping push down the prices for oil and commodities in general since most are priced in dollars.The near collapse in those commodities will push many overleveraged producers to file for bankruptcy and force the survivors to significantly curtail budgets. We’ve already witnessed outsized layoffs in excess of 150,000 in the sector with more to come. This is just direct layoffs in the energy and mining sectors not that me be directly or indirectly affected such as equipment providers Deere (DE), Caterpillar (CAT), GE (GE) etc.In the indirectly geographically affected areas like Texas, Pennsylvania Oklahoma etc. we’ve seen a slowdown in construction projects ,layoffs in restaurant staff, drycleaners, bar staff etc. 

Aside from the drags on the economy from cheaper energy and food stocks there is a definitive and very visible benefit to both business and consumers alike. Conventional estimates point to a $193 billion annual savings to the consumer from the decline in gasoline alone. For every $.01 drop in the cost of gasoline this would point to an equal $1 billion in savings to consumers.  From the 2011 average of $3.53 (high was $4.12)  to today’s current price of $1.60 leaves consumers with $1.93 or $193 billion in extra discretionary spending.  While not exact the figures are pretty impressive. As consumers gain confidence that lower prices are here for longer those dollars should find their way out of savings and back into boosting consumer spending. This massive figure doesn’t even take into account the savings on heating oil and natural gas.Further, companies use natural gas and liquid gas as a feedstock to make plastics, tires, aerosol, refrigerants, power barbecues, detergents and foam among others items/products you may use.You can see this touches consumers' everyday lives and benefits us all in one or more products and savings.  

As for the overall domestic economy growth remains constrained below its long term average growth rate of +3.25% with 2015 estimated to come in at +2.2% with a slight improvement expected in 2016. Headwinds remain: a strong US dollar, weak emerging economies and fears of rising interest rates.Tailwinds include a robust domestic service sector, aerospace and auto sectors are firing on all cylinders, strength in housing, rising consumer confidence, increasing wages and fairly robust job creation along with a still very accommodative Federal Reserve policy. Add in that India’s economy has overtaken China as the fastest growing major economy and expected to outpace by a full 1% to 7 ½% in 2016. Lastly, you have to take into account the slow steady recovery taking place in the Eurozone. The Eurozone should exit 2015 at +1.6% growth and we look to 2016 for modest improvement to +1.8%.  

These major crosswinds are the catalysts driving the turmoil in the markets along with generating angst among investors and CEO’s alike.During highly volatile market swings investors sometimes cave into fear and move to liquidate positions seeking the safety of cash. Similarly, CEOs during times of uncertainty and low visibility for their business prospects cut back on capital expenditures and hiring. These can exacerbate the emotions and selling to say the least.  The market volatility is here to stay and gains in 2016 will be hard fought for.   Now is not the time to wager on so called Unicorns as many gamblers did after watching Onion stride to victory over Secretariat only to watch him huff turf a few weeks later at the Marlboro Stakes. Now is the time to go with the best of breed. Investing in companies with a proven business model, management with a vision and plan backed by solid revenue growth and earnings coupled with a an attractive dividend to help cushion the ride around this track we’re all too familiar with, even if it feels different this time around. 

For now we remain committed to the market closely monitoring data along with any signs to change course in which case we’ll be in contact immediately. 

Investor Alert!  The Equity markets are taking their direction from energy.  Plain and simple.  Oil broke through $30  on Friday.  Should that selling pressure and price decline continue on Monday we advise adding to cash positions as $22-$25 would be the most logical next stop.  The market remains oversold but can remain so for some time.  So, adding to cash positions until oil finds a base would be a cautious but prudent step.  When the oil market bottoms there will be plenty of time to reengage. So, researching and building out your watchlists would also be a prudent use of time.  We urge against attempting to pick through beaten down energy and mining companies. The supply demand equation is incredibly difficult to predict with more Iranian and Libyan oil coming back to the markets while demand remains consistent while not strong enough to absorb all that is still sloshing around or being pulled out of mines.