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Financial Key Points

·         Falling oil prices are causing near-term uncertainty but should benefit economic growth over time.

·         The Fed may signal this week that it is getting ready to begin increasing interest rates.

·         Economic growth continues to improve, which should act as a further tailwind for equity prices.

The dominant financial story last week was the concern over the continued slide in oil prices, which have dropped close to 40% so far this year.1Worries about the growing power of the Greek opposition party Syriza, and the potential effect on European policy should it assume control over the government, also contributed to investor unease. For the week, the S&P 500 Index fell 3.5%, snapping a seven-week winning streak and suffering its largest one-week pullback since May 2012.1 Energy stocks led the decline, while some defensive sectors such as utilities fared better.1 High yield bonds also sold off and investors poured money into Treasuries as risk aversion spread.1

The Benefits of Lower Energy Prices Outweigh the Risks

Falling oil prices do present risks. Lower prices hurt energy producing companies and regions and, as we saw last week, any sudden or sharp moves in financial markets can spill over onto other asset classes. Overall, however, we believe lower oil prices will help economic growth. Consumers should benefit most, as money spent on gasoline and heating costs can be redirected to other areas.

Weekly Top Themes

1.    This week’s Federal Reserve meeting may mark an important shift in tone. Specifically, we expect the Fed could drop the phrase “considerable time” when discussing how long it intends to keep the fed funds rate near zero. This would mark the beginning of a multi-month process of preparing the markets for the first rate hike, which we believe could occur in mid-2015.

2.    Strong retail sales figures act as additional evidence of improving economic growth. Sales climbed 0.7% in November, the strongest gain we have seen in eight months.2 These results should help assuage any concerns about a weak holiday shopping season.

3.    Small business confidence is rising, which should help employment gains. November’s Small Business Optimism Index rose to its highest level since 2007.3Since small businesses typically drive jobs gains during economic expansions, this bodes well for the future of the labor market.

4.    Inflation remains low, and there is little sign that expectations will rise. Despite a months-long trend of economic data that have been exceeding expectations, inflation levels remain subdued. Lower oil prices and a stronger U.S. dollar are helping to keep downward pressure on inflation.

5.    The history of the presidential cycle suggests equities could benefit in 2015. Next year will mark the third year of the presidential cycle. Since 1950, the S&P 500 Index has averaged a 16.5% annual return during those third years.4 In particular, January has been a strong month, showing a 4.3% average return with only one decline during that period.4

1 Source: Morningstar Direct and Bloomberg, as of 12/12/14
2 Source: U.S. Department of Commerce
3 Source: National Federation of Independent Business
4 Source: Strategas Research

The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy.

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