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The Markets This Week

May 21, 2018 | Weekly Commentary

by Connor Darrell, Head of Investments
Both large cap stocks and bonds ended the week marginally lower, but the heightened volatility observed over the past few months seems to have waned for the time being. Internationally, stocks traded largely in line with those in the U.S., although emerging markets stocks had their worst week in quite some time. Emerging markets stocks have faced headwinds from the increasing strength of the U.S. Dollar, which reached a five-month high last week.

US small cap stocks were a bright spot last week, and have been all year. The Russell 2000, which tracks a broad basket of small cap stocks, is up over 6% so far this year, outperforming the S&P 500 by about 4%.

Oil Prices on the Move
It is easy to forget that there was a solid four-year stretch from December 2010 to November 2014 where the average retail price of a gallon of gasoline in the US was well over $3. But a confluence of factors (including technological advances that increased US oil production, as well as a concerted effort by members of OPEC to put a squeeze on those same U.S. producers) led to a massive decline in the price of oil beginning in late 2014. From peak to trough, the total price decline was over 70%, and consumers reaped the benefits for a number of years. However, that has changed rather dramatically in the last 12 months, as prices have come roaring back.

The surge in oil prices over the past year has been driven by a variety of influences, including increasing demand driven by strong global economic growth, cooperation between Russia and OPEC, economic collapse in Venezuela, and logistical inefficiencies disrupting the distribution of US shale oil. On top of this, the Trump administration’s decision to withdraw from the Iran nuclear deal and re-impose sanctions could lead to a decline in Iranian production, which would further deepen the supply shortfall.

In the near term, the rise in oil prices has the potential to increase inflation and pose as a headwind to economic growth (albeit not nearly large enough to offset the benefits of recent tax reform). We have discussed in the past that the Fed is watching inflation closely, as it is one the key indicators that helps to dictate monetary policy. However, the Fed is unlikely to be coerced into altering its path of normalization by something as fickle (and potentially temporary) as rising oil prices. It is more likely that the worst side-effect of the recent run up in oil prices will be some pain at the pump during the summer travel season.

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