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Macro View

As 2014 starts to wind down, we see oil prices headed south along with bond yields and equity prices closing near the highs for the year.  This is a happy state of affairs for most, as 401(k) values are getting a boost while daily living expenses get a bit easier to carry.  In contrast to the oil shocks that occurred in 1973-1974, 1979, 1980, 1990, and 2003-2004, today’s sharp drop in oil prices is conveying benefits to the average worker who has been struggling to see a real increase in wages.  With the average price for a gallon of unleaded gasoline near $2.55 last week, the sudden fall in energy prices positively affects consumers’ income and increases spending.  We expect that headline inflation will likely move lower, and the output gap will close faster than would be the case otherwise.  In past episodes, when oil prices were declining (1986 and 1999, for example) the economy benefitted from noninflationary growth.

The oil story certainly carries worries for investors in the domestic energy exploration area.  These concerns are being reflected in falling junk bond prices where there has been significant issuance in energy-related areas.  Against a backdrop of generally rising Treasury prices, the price of the Barclays U.S. Corporate High Yield Index has dropped to 1,595 from a high near 1,670.  The widening spread between Treasuries and high yield partly reflects concerns about potential default risk in the energy area as the result of lower oil prices.  The market is of particular interest given the fact that, in each of the past three years, more than $300 billion of new high-yield debt has been issued.  This robust level of issuance is roughly three times the issuance of the 2005-2008 time period.

The rapid growth of the oil and gas industry in recent years has also created fast growth in jobs within the sector.  According to the Bureau of Labor Statistics, for example, the growth in jobs during the first part of the economic recovery was far more rapid than overall growth in employment.  Oil and gas industry jobs increased by 40% over that period for a total increase of 162,000 jobs.  To put that number in further context, total private sector employment increased by slightly more than 1 million jobs.  By this measure roughly one out of every six new jobs came from oil and gas.  Hence, the industry is important to the domestic economy not only as a way to reduce dependence on uncertain Middle East oil, but also as a means for generating jobs.  The fall in price is a double-edged sword.  While we view the lower price conveys benefits at the pump and will put money in consumer’s pockets, there are other implications as well.

2015’s U.S. economic growth should see a net benefit from lower energy prices, continued growth in employment, and steady final demand.  Business investment spending continues to climb as a percent of Gross Domestic Product (GDP), suggesting improving sentiment at the employer level.  Significant divergences in growth are emerging globally, however.  After two quarters of +4% growth in the United States, Europe and Japan appear to be stagnating, but the gap in growth should eventually narrow, as we don’t expect to see the global economy to run in opposite directions indefinitely.  As for emerging markets, we see that countries such as Brazil, Russia, and China with significant macro-imbalances (or highly dependent on oil exports – Russia) will suffer a greater penalty to growth.  Other emerging markets with sound policy, manageable levels of external debt, and strong export industries should fare well by comparison.  Overall, we maintain our preference for U.S. equities versus foreign given relatively more consistent growth here at home.