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Portfolio Update

Lower Oil Prices and Economic Growth

By Elliott H. Gue, on Jan. 18, 2015

The S&P 500 kicked off the new year with a modest correction, pulling back about 5 percent from its late December high to its early January low.

Regardless of how the mainstream media explains the selloff, this bout of profit-taking is a healthy development after the S&P 500 surged by 15 percent from its mid-October low to its high in late December.

Excluding gasoline and automobiles, December retail sales fell 0.3 percent, falling short of the 0.5 percent increase called for by the consensus estimate. This disappointing report garnered more attention than usual because economists had expected low interest rates, a strengthening labor market and a big drop in energy costs to fuel robust retail sales.

But history has shown that six to nine months often need to pass for a stimulus such as lower energy prices to appear in real economic data.

Also recall that crude oil fetched more than $80 per barrel as recently as early November 2014; after several years of elevated oil prices, consumers need a quarter or two to adjust their spending habits.

The Federal Reserve’s January Beige Book highlighted signs of economic weakness related to the collapse in oil prices, with Dallas reporting a slowdown in hiring and rising layoffs in the energy sector.

The combination of weak retail sales and the worrisome trends highlighted in the Beige Book led to a proliferation of articles concluding that the drop in energy prices will prove to be a net negative for the US economy.

This thesis is ludicrous. Monthly changes in economic data include significant amounts of noise, including inconsistent seasonal adjustments and regional weather conditions.

Weak US retail sales may end up being an anomaly; most data points point toward solid economic growth heading into early 2015.

Even experienced economists are prone to confirmation bias and data mining; given the welter of data points and economic commentary available, you can find support for almost any conclusion or prediction.

We prefer to focus on a handful of indicators that have proved their value over time. Our favorites include the Conference Board’s Leading Economic Index and the Institute for Supply Management’s Purchasing Managers Index for the manufacturing sector.

Until these forward-looking indicators show signs of deterioration, we stand by our view that the US economy remains on a solid growth track.

Quarterly earnings will drive the S&P 500 over the next several weeks. Investors shouldn’t rule out a deeper correction to about 1,900 for the S&P 500; however, the next major move should be the upside.

Against this backdrop, investors should take advantage of any pullbacks to add to or establish positions in the Wealth Builders Portfolio’s buy-rated stocks.

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