Everyone who grew up watching the Beverly Hillbillies knows that Black Gold is oil. The drop in the price of oil was one of the two biggest stories of the last half of 2014 on Wall Street (interest rates are the other). The price of oil has fallen by more than half over the past six months and we are seeing the happy results at the gas pump (when was the last time you filled up for less than $2 per gallon?).
It would stand to reason that the price drop is great for the US economy because it will give people more discretionary income to spend on other things. It should especially help the middle class as they have had almost no discretionary income for several years. In theory, the just completed holiday season should have been a blockbuster one with big sales gains virtually across all retail segments. Only it didn’t happen as predicted although retail sales for December were 3.2% higher than in a year ago.
It appears that instead of spending their new found money, consumers are using it to either pay down debt or increase their saving rate. Some of this can be blamed on timing. For many, the drop in gas prices came too late in the year for them to spend the money. Others may just be saving up for a major purchase that is still to come (such as a new vehicle or home). We will have to watch the retail sales over the next few months to see if Americans start to spend more or save more.
The other big story over the past six months has been the continuing fall in interest rates. While just about everyone expected interest rates to rise in 2014, they didn’t. In fact interest rates have fallen so far in some countries in Europe that they are now negative. That’s right … instead of getting paid own government bonds, you have to pay them to own government bonds. The idea is to discourage saving and holding cash and encourage spending it.
While other central banks continue to lower rates (mainly the Japanese and the Europeans), the US is looking raising rates. The current thinking is that the US Federal Reserve will start to raise rates as early as June. This is actually not that unusual. The US has often been the first country to go into a recession and then been the first to come out, with Europe usually trailing by 12-18 months. Whether that scenario will repeat itself again this time is still to be determined.
So what does all of this mean to you, the investor? Higher interest rates mean that you will finally make something on your savings accounts. It also means that the price of bonds will drop, but since we like to hold bonds to maturity, it won’t matter much to your portfolio in the long run. On the equity side, I believe that stocks are pretty expensive right now and I am finding it increasingly difficult to find good values and may look to lock in some gains on high price stocks if interest rates rise enough or if I find some better values.