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Daily Agenda: Russian Economy a Cornered Bear

Aramco raises oil export prices; European service sector PMI signals slowing activity.

While slowing global growth concerns and plummeting oil remain worries, the domestic situation in Russia is causing trepidation among geopolitical analysts concerned about a response from a beleaguered Kremlin. The ruble, at 63.5 to the U.S. dollar, has recovered from the sudden sell-off in December, but anecdotal reports of shortages in staple food items and the massive amount of euro/dollar-denominated debt in the Russian private sector suggest that the pain is far from over. For now, a game of one-upmanship appears to be the order of the day in Moscow but as the domestic situation continues to deteriorate, President Vladimir Putin faces increasingly slim chances of a solution that can provide economic relief while allowing him to save face.

Aramco raises prices. In a statement yesterday state-owned Saudi Arabian Oil Co., also known as Saudi Aramco, announced that it would reduce the discount on prices for Asian-bound exports for February. This incremental increase may signal that the world’s largest oil company may be tapering the pressure it recently has carried in global oil markets recently.

European service sector continues to show signs of slowing. Service industry purchasing manager index (PMI) levels for December released for primary European economies released today showed mixed results, with Italy registering a contraction at 49.4, France and Germany’s numbers revised up and aggregate euro zone levels that were below consensus forecasts. On bright spot in the data was France, which rebounded to a positive reading for the index measuring manager sentiment in the services industries, the first positive final reading since August 2014. In the U.K., final December Markit services PMI contracted to 55.8 versus a prior 58.6 and consensus forecast for 58.5. This marks the lowest reading for the measure in the country since 2013.

Oversold? The euro reached a post-2005 low versus the U.S. dollar yesterday, prompting speculation that the regional currency’s sell-off may have reached an overextended level in advance of anticipated action by European Central Bank president Mario Draghi. After German consumer inflation data released yesterday showed its lowest level since 2009, concerns over deflation in Europe — and what the ECB can do about it — remain paramount in market risk narratives. Multiple economists at primary banks anticipate a negative year-over-year reading driven largely by falling commodity costs when December euro zone Harmonized Index of Consumer Prices consumer inflation levels are announced tomorrow.

Economists forecast contraction in U.S. activity. Institute for Supply Management nonmanufacturing PMI and November factory orders are the primary releases for the day in the U.S. After registering weaker than expected in October, analysts forecast further contraction in new orders for the industrial sector on a month-over-month basis.

Portfolio Perspective: Key Tactical Themes for 2015Adam Grimes, Waverly Advisors

We see a few key themes that stand to dominate trading in 2015. With regard to equities, for the past year we have been saying that we are somewhere in a historic bull market. Whether we are at the beginning, middle or end, history will tell us. But every sign points to us being somewhere nearing the middle of that bull market. There could well be three to five years additional upside, and returns approaching triple digit percentages. Though that seems optimistic, a number of structural and quantitative factors support this assessment. For the foreseeable future, we see the U.S. set to lead the world, powered largely by healthcare, financials and technology, with materials, staples and energy set to lag.

In terms of volatility, we see little reason that equity volatility cannot remain at or near historic lows. This is consistent with the structure of the bull market, however it does bring some challenges for risk management. There are opportunities for active hedgers who cross the line into speculative long-volatility positions to take quick profits on high-vega positions, but more static hedgers will face challenges. Consider the potential for volatility to multiply two- or threefold within the span of a few days, and then to quickly decline.

For interest rates, we continue to think it is premature to assume that any move has to happen on any timeframe. Rates can stay near current levels for an indefinite length of time. Make no assumptions.

On the currency front, we see the U.S. dollar set to extend strength for at least another quarter, and perhaps much longer. Parity for the euro is not out of question.

There are essentially three groups to consider for commodities: Crude oil and distillates could have considerable downside potential from current levels; front month crude in the low $40s per barrel is not out of the question. Precious metals are in a holding pattern but structural factors continue to suggest downside, with gold futures targeting the low $800s per ounce. Domestic grains are neutral, but we do not see strong support for a continuation of the downtrends during the second half of 2014.

Adam Grimes is the managing partner and CIO of Pittsford, New York–based research and asset management firm Waverly Advisors.

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