Koenig Investment Advisory

Federal Reserve and Interest Rates

The long anticipated Federal Reserve increase in interest rates is expected to occur this month. While the rate change itself is likely to be a modest 0.25%, the stock market does tend to get a little nervous over interest rate increases until two are behind them. The second rate increase is expected for the first quarter of 2016, meaning we are likely to see increased market volatility through March. A variety of factors influence the Federal Reserve on when to increase interest rates. Three factors to note in this current cycle are employment, wage growth, and consumer debt.

Employment – Nonfarm payrolls are up 2.8 million in the past 12 months ending October. This is the best growth in a 12 month time period since late 1999. October’s employment report was released in early November with surprisingly strong figures. This was interpreted as a further push towards the beginning of the Federal Reserve’s long telegraphed move to increase interest rates. November’s employment report released December 4^th was also strong, showing 211,000 new jobs with the unemployment rate steady at 5.0%.¹

Wage Growth – The US economy is starting to see signs of accelerating wage growth. Average hourly earnings have increased 2.5% in the past year. This is the biggest increase since the start of the downturn in 2008.²

Consumer Debt – Measures of the obligations consumers take on each month for categories like mortgage debt, car payments and credit card payments, the current ratio of income to debt is one of the best since the early 1980’s. Debt delinquencies – including mortgage debt, auto loans, credit card loans and home equity loans – combined are currently $50 billion lower than a year ago.²

In summary, more Americans are employed, their wages are rising and they are more likely to be meeting their debt obligations than they were a year ago. The news at the corporate level is also largely positive. Most analysts expect U.S. companies to post higher earnings in 2016 than they did in 2015. The biggest factor in a company’s stock price is the company’s earnings. We may see interesting price fluctuations as some investors react to the Fed’s interest rate increase, but the overall picture for U.S. stocks is one of modest gains.

Oil

Saudi Arabia has been the biggest factor in lower oil prices. They felt themselves losing influence within the global energy sector and decided to throw their weight around. The objectives were to inflict pain on Russia and Iran, while undercutting the U.S. fracking industry. Russia has suffered, Iran has not due to the lifting of sanctions, and fracking output has declined in the U.S. The Saudis did not count on the efficiency gains U.S. frackers have been able to achieve, thereby, causing less of a decline in the industry than had been hoped for.

Obviously, large state-owned oil producing countries can’t flood the world with cheaper oil without direct economic pain. These nations are now drawing upon foreign reserve accounts in order to fill the gaps created by lower revenues. Russia and Venezuela are experiencing more severe pain than other oil producing countries. Saudi Arabia’s net foreign assets declined by $90 billion from February 2015 through September 2015 as they began to tap into reserve accounts, with the full year total drawdown total estimate at $120 billion.³ The biggest Arab economy is burning through financial assets needed to support domestic spending and could fully deplete these reserves within five years if current policies are maintained. Even stable oil economies like Norway have started to draw on reserves due to lower oil prices. At some point the ongoing economic reserves will be drawn down. Analysts are currently looking to the end of 2016 or into 2017 before Saudi Arabia is willing to curb current output levels and revert to more typical production and pricing.

On December 4^th OPEC stated that it was going to raise its oil output ceiling cap to 31.5 million barrels from a level of 30 million barrels. Given that they have already been producing 31.57 million barrels a day in recent months this is largely a symbolic move rather than a real change in production levels.⁴

Summary

We continue to see a great number of media reports regarding the economy that do not accurately portray the financial outlook of the average American household and business. While our economy is not growing at leaps and bounds, the picture is more positive than negative. Not every family or business has recovered from the financial crisis of 2007-2008, but the overall economy has. It has taken years, but slow, plodding growth adds up over time. Stories speaking about imminent doom and gloom cherry pick data points in order to appeal to the emotions of readers. They do not give an accurate picture of either the status of U.S. businesses nor households as a whole. The U.S. economy is not perfectly poised and many families do have issues with making ends meet. There will always be weak spots in an economy as large as that of the United States. A country with a population of 320 million is going to see some members financially unstable. However, most companies are currently experiencing growth and most family finances show improvement. Trumpeting that reality does not generate excitement and often loses out to stories with eye grabbing headlines.

Please remember that the market is closed on December 25^th and January 1^st. It closes early on December 24^th and 31^st. We hope you and your families have a pleasant holiday season.

The information contained in this newsletter is for general use, and while we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different. The information provided is not written or intended as tax or legal advice and may not be relied upon for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a solicitation of the purchase or sale of any securities.

December 2015

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