In this commentary we highlight some key market developments from the fourth quarter, recap 2014 performance for the key asset classes we invest in, review our portfolios’ resulting performance, and, in light of the past several years’ sharp outperformance by U.S. stocks compared to the rest of the world, take a brief diversion to discuss why we continue to believe in globally diversified equity portfolios. We then tie things up with an update on our current asset class views and portfolio positioning, including a deep dive into the performance of our active equity managers.
A Tumultuous End to the Year
While a plunge in oil prices caused global financial instability in the latter part of the quarter, stock markets were ultimately soothed, once again, by central bank lullabies of continued accommodative monetary policy.
OIL WAS THE TRIGGER
Oil prices were down 40% for the quarter hitting five-and-a-half-year lows in late December (based on Brent spot prices). An oil price decline is typically viewed as an unambiguously positive development for the global economy as it benefits consumers (serving as a tax cut and increasing their purchasing power) and most businesses (reducing their input costs). It also reduces inflationary pressures. Better economic growth and lower inflation is a win-win. The negative impact of lower oil prices on the increasingly important U.S. shale energy industry complicates the picture a bit for the U.S. economy. But most of the analyses we’ve seen still estimate a positive net economic impact, for both the U.S. and global economy.
However, the oil price decline this time is different because of the rapidity of the plunge, and the current fragile (deflationary) global economic environment. Market prices are a function of supply and demand. New sources of oil supply from U.S. shale, Libya, and elsewhere have been increasing. Meanwhile, in late November OPEC said they would not cut their production in the face of falling prices. But, the sharp price drop also reflected fears of a deeper weakness in global demand. For example, in early December both OPEC and the International Energy Agency (the Paris-based energy adviser for developed nations) reduced their 2015 estimates of oil demand growth.
With deflation concerns already high in Europe in particular, the oil price decline was seen as intensifying the deflationary risks. There is “good deflation” (i.e., falling costs driven by productivity growth and efficiencies) and bad deflation (i.e., falling costs driven by inadequate demand and excessive debt deleveraging). The financial markets’ volatility in early December signaled that investors were worried the oil price declines were indicative of the latter. And as always in financial markets, momentum and herd behavior can take over and create a self-feeding spiral (positive or negative) that often extends well beyond the original issue (in this case, oil). As such, with falling oil exacerbating an already precarious economic situation, the Russian ruble plunged more than 40% against the dollar during the quarter and there was renewed talk of contagion risk and a potential repeat of the emerging-markets currency crisis of 1997–1998.
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