Stocktake: pace of rate hikes key for stocks

Pace of rate hikes key for stocks The most long-awaited interest rate hike in history will surely come next week, with the Federal Reserve expected to raise interest rates for the first time in nine years.

At this stage, anything other than a rate hike would shock investors; Fed chief Janet Yellen last week described the "case for liftoff" as "compelling", and futures data now indicate the odds of a rate hike to be in the region of 75 per cent. The speed of subsequent rate hikes will be key to the performance of equity markets in 2016. According to Ned Davis Research, stocks enjoyed an average gain of 10.8 per cent one year after the first rate increase during slow hiking cycles. Things are very different during fast hiking cycles, however, with stocks suffering an average decline of 2.7 per cent.

Fast hiking cycles have been the norm in recent decades – seven of the last eight tightening cycles have been seen rapid rate hikes – but Yellen has made it clear that the Fed is going to take it very slow in the coming years. This is expected to be the slowest hiking cycle in history; unless that narrative changes, bulls are likely to view future Fed policy with relative equanimity. Pain trade hits Europe A fortnight ago StockTake cautioned euro-dollar parity was not a one-way bet, warning that a counter-trend correction was possible due to the 'long dollar' trade being the most crowded position in global markets. The dangers of lopsided positioning were realised last Thursday, when the euro recorded its biggest one-day gain against the dollar since 2009.

The source of the move was disappointment regarding the scale of the latest ECB stimulus package. European stocks, too, were hammered, with indices in Germany and France losing 3.6 per cent.

There is always the potential for such moves when sentiment gets out of whack. Last month's Merrill Lynch fund manager survey revealed everyone was betting on the dollar, and global investor bullishness towards European stocks was near record levels. The "biggest pain trade appears to be in European stocks", Merrill cautioned, "if the dollar wobbles against the euro".

Last Thursday the dollar did indeed wobble, causing export-driven European stocks to tank. The lesson? It can seem like there is no risk when everyone is leaning the same way, but that is precisely when the risks are greatest. Will Santa be early for stocks? There's a lot of chatter at the moment regarding the so-called Santa Claus rally. Strictly speaking, Santa isn't due to come to Wall Street yet – market historians note the Santa rally refers to the seasonal strength characterising stock markets during the last five sessions of the year and the first two sessions of the new year – but strength is not confined to that period.

Raymond James strategist Jeffrey Saut last week noted that over the last 20 years, US stocks gained from November 20th into year's end on 18 occasions. From December 16th, stocks rose in 24 of the last 27 years.

The pattern also holds for flat years such as 2015. Nautilus Capital found seven years where stocks were flat leading into December; equities rose into year-end every time, with gains almost five times that seen in an average month.

The same is true of the UK, where December has been the best month over the last three decades. Hargreaves Lansdowne notes stocks have enjoyed a 15-fold return since 1985, but more than half that gain would have been erased if you exited each December.

Investor enthusiasm tends to mount as the month progresses; according to Axa Wealth, the last two weeks of the year are “the strongest fortnight in the calendar”.

Analysts and rainy day blues Bad weather is not conducive to equity analysis, a new Standford study suggests.

The researchers, having examined reports from 5,456 analysts based in 139 different US cities, found analysts were 9 to 18 per cent less likely to issue an earnings forecast, a stock recommendation or a stock price target during “unpleasant” weather conditions.

The “rainy day blues” sapped energy levels, they suggest, causing an “under-reaction to both positive and negative information”. This has “potential market implications”, with lower trading volumes around earnings announcements during spells of bad weather.

“My work has been murky today because the weather was murky,” Voltaire once said. Equity analysts might agree. See http://goo.gl/te0e5u