In the first half of 2015, the US stock markets saw intraday volatility, although they traded within a relatively narrow band through the end of June. Then, a slow decline began in mid-July, which culminated in a “Flash Crash” type of drop on August 24th, 25th and 26th. For the next month and a half, news reports incorrectly attributed this decline to worries over the slowing Chinese economy. Proof that this attribution was incorrect lies in the October rally, which took the market back to its earlier range despite no change in the Chinese economy. In our September 30th commentary, we discussed the stock market liquidity issues that caused such volatile declines at the end of the summer. One could equate the August/September “Chinese panic” decline to the “Ebola panic” decline of 2014. Recall in the fall of 2014 when the markets fell over fears that an Ebola epidemic might start in the US (of course, this never actually happened). Both “China” and “Ebola” were hotly-discussed topics in the media, yet neither was the real root cause for the stock market decline.

Stocks were not the only market to suffer from impaired liquidity. Bonds rated lower than investment grade, or so-called “junk bonds,” declined significantly in the fourth quarter due to illiquidity among the riskiest issues. This decline created a crisis, which forced a large fund, the Third Avenue Focus Credit fund, to liquidate.

For 7 years, the longest period on record, the benchmark Federal Funds rate has been virtually 0%. On December 16th, the Federal Reserve raised interest rates for the first time since August 2006. This move had been anticipated for years, and was probably the most widely telegraphed move the Fed has ever made. The Fed started the process of applying monetary restraint in the fall of 2014 when they stopped adding to the bonds on the Fed balance sheet. This bond buying was the stimulus program known as Quantitative Easing. In December, Fed Chair Janet Yellen finally took the long-anticipated step of raising short-term (one day) rates from the 0-0.25% range to a target of 0.25-0.50%. Now the focus is on when the next 0.25% increase will occur. Notice on the long-term chart how truly miniscule this move was.

Unemployment has declined steadily from a high of 10% in October 2009 to the November reading of 5%. This level is generally regarded as the “full employment” rate and has given the Fed motivation to raise their target interest rate. However, since wage growth has been subdued, increasing from 1.8% in 2010 to a meager 2.3% in the last report, the Fed’s move to restrain was small.

The price of crude oil declined from $100 per barrel in mid-2014 to just below $50 by the first quarter of this year. The price then rose to $60 in the second quarter as it looked like it was stabilizing, but it has since declined to around $35 per barrel. As a consequence, energy stocks performed very poorly in 2015, as did the low-rated bonds of some energy companies, which led to the problems referenced above at credit funds such as Third Avenue’s.

In the fall of 2014, as the price of oil began its decline, economists predicted that consumers would receive a benefit from much lower gasoline prices and that this “gas dividend” would boost consumer spending. So far, it seems that the “gas dividend” has been saved, not spent. This is contributing to the tepid nature of the economy. Many of the retailers have provided dismal outlooks for the year, with a few notable exceptions, including the online retailing giant, Amazon (tkr: AMZN).

The US dollar began rising in the last half of 2014, continued its rise through the first quarter of 2015, and traded sideways in a somewhat volatile fashion through the remainder of 2015. We anticipate that the US dollar’s strength will continue this year alongside additional monetary restraint by the Fed, whether via higher rates or a reduction in its balance sheet. Consequently, we believe now is not the time to overweight foreign equities.

Meanwhile, we have all been entertained by the newest reality TV show: the Primary Debates. For the Democrats, it is most likely that Hillary Clinton will be the nominee. She won in Iowa with a razor-thin victor over Bernie Sanders. Who will emerge as the eventual leader on the Republican side is anyone’s guess. So far, it has mostly been the Donald Trump show. Ted Cruz has tripled his standing in Iowa in the last 2 months and now leads Trump, with Marco Rubio in third. Meanwhile, Ben Carson, who was leading in late October, has dropped to a distant 4th. Look for more lead changes as we come into the first turn of this horse race.

Late last quarter, on September 25th, John Boehner resigned his position as Speaker of the House. On October 29th, after much politicking and uncertainty, Paul Ryan was finally elected Speaker. Ryan is viewed as a policy wonk with deep expertise in financial issues, so we hope for the possibility of future tax simplification. However, we remain concerned about the consequences of the Republican Party losing all semblance of unity.

Today the P/E ratio on the S&P 500 is about 18.3 times and the 10-year US Treasury is yielding 1.85%. Real estate capitalization rates (the rate of return on a real estate investment property based on the income that the property is expected to generate) are below 5% on institutional quality commercial properties. Money is in ample supply and any investment with yield is expensive. We are optimistic that the US economy will lead the world, but we acknowledge that the current rich valuations could keep returns modest in 2016.

Individual investment positions detailed in this post should not be construed as a recommendation to purchase or sell the security. Past performance is not necessarily a guide to future performance. There are risks involved in investing, including possible loss of principal. This information is provided for informational purposes only and does not constitute a recommendation for any investment strategy, security or product described herein. Employees and/or owners of Nelson Roberts Investment Advisors, LLC may have a position securities mentioned in this post. Please contact us for a complete list of portfolio holdings. For additional information please contact us at 650-322-4000.