Oil futures will decide how Dow ends the year

SANTA Claus showed up late and short-handed at Wall Street this year. Now, a struggle between the bulls and the bears will be decided on the last week of the year.

Even after registering their biggest weekly gains in more than a month last week, US stocks are down for December and more or less flat for 2015. Traditionally, December is one of the strongest months as "tax-loss" selling gives way to the accumulation of stocks for new retirement plans.

A week ago, it looked as if this December would be one of the worst in living memory for US stocks and that this would be the first negative year for the S&P 500 since 2011. The Federal Reserve's rate hike had thrown global markets into turmoil. The knock-on effects in commodity markets threatened to spark another financial crisis. The high-yield debt market where small, high-risk companies go to borrow money was freezing up as thousands of energy companies saw their viability tested by oil prices.

Last week's stock market rally was sparked by a roughly 9 per cent gain in oil futures, which, in turn, alleviated pressure on junk bonds. Some analysts say that was merely a temporary phenomenon, the result of short-sellers buying back contracts they had sold to profit from losses. If oil futures slide again this week, Santa's gift to Wall Street - last week's gains - may be stolen by the Grinch.

One strategist hinted that the lows of around US$34 a barrel last week were an inflection point for oil prices.

"We're starting to see a bounce" in oil prices, said Phil Orlando, chief equity strategist at mutual fund firm Federated Investors. Mr Orlando said the reduction in exploratory activity on US oilfields, the onset of winter storms after a mild winter to date in North America and rising demand in developed economies would drive oil prices higher.

Much of the 2015 slowdown in corporate earnings growth was attributable to energy and ancillary areas, Mr Orlando added. Even a flat oil price this year could result in a rebound for earnings.

In its long-term outlook last week, the Organization of the Petroleum Exporting Countries (Opec) hinted that it would eventually rein in production. For now, however, the cartel is playing a game of chicken with American shale field operators, with each side waiting for the other to reduce production.

One US oilman said US drillers preferred to operate at a loss than to "shut in" wells because some wells never recover from the effects of caps that are supposed to be temporary.

This means another wave of bankruptcies is likely in 2016, unless oil prices continue their recovery.

Another reason for the periodic stock selloffs in 2015 were the worries about valuation. After a long bull market, some stocks - particularly biotech and technology stocks - were trading for much more than their earnings prospects warranted.

By one measure of valuation, however, the stock market looks relatively cheap. Sam Stovall, chief equity strategist at Standard & Poor's unit Capital IQ, said the "dividend yield" of the Standard & Poor's 500 was still very close to the 10-year Treasury yield. In other words, an investor could lock in almost as much interest payments by buying stocks as they could by buying bonds.

"This narrow spread continues to offer encouragement to equity bulls, as they attempt to divine the market's performance in 2016," said Mr Stovall. "Since 1953, whenever the 10-year Treasury yield was higher than the 500's yield by less than 100 basis points (or one percentage point), the S&P 500 gained an average 12 per cent in price during the subsequent 12 months, and recorded positive results nearly 90 per cent of the time."

Another variable for 2016 is China's growth rate. The unexpectedly sharp downward trend in gross domestic product (GDP) and manufacturing sector growth in China was arguably the biggest deterrent to gains on global markets this year, after the prospect of a Fed hike. One money manager argues there's reason to believe that China was in transition from an emerging, manufacturing-and-export oriented economy to a developed world consumption driven economy.

"The continued acceleration of outbound leisure travel from China is one more sign to us that the Chinese consumer, who will increasingly be the engine of the Chinese economy (as consumers are in the developed world), is in good health - increasingly willing and increasingly able to make discretionary expenditures," said Tim Shirata, executive vice-president of money manager Guild Investment Management, in a note to clients.

Even stronger than December, traditionally, is the month of January. That's when institutional investors go shopping for stocks, motivated by huge influxes of cash from new and re-allocations for 401(K) plans and other retirement accounts.

Historically, Mr Orlando said, negative Decembers have often foreshadowed negative January. Another stock market axiom says "as goes January, so goes the year".

In other words, the course of this week for oil futures and the stock market could do much to decide the back-and-forth battle between the bulls and the bears that raged all year.