by Scott Minerd, CIO, Guggenheim Partners LLC
June 11 2014
When bull markets mature, investors fear a coming crisis and today there are plenty of candidates from Europe to China to Thailand. Still, some of the best profits may lie ahead.
Global CIO Commentary by Scott Minerd
After the recent prolonged rally in U.S. fixed income and equities, we are now in the late stages of a bull market cycle. While such markets are difficult to navigate, they can still be profitable. In my new Market Perspectives piece, I write about how Guggenheim sees gradations in the theme of overvaluation across the spectrum of fixed income (as seen in the chart below), and about how we are approaching this late stage of the bull market in credit.
Despite tight spreads, history tells us that credit spreads can tighten further. However, it is worth remembering that bull markets do not die of old age. Instead, they typically die of a policy mistake when central banks raise interest rates too quickly and snuff out an expansion or raise them too late and fail to slow economic overheating, often after certain asset prices have reached unsustainable levels. There is little reason now to expect the former from the U.S. Federal Reserve, which is unlikely to raise rates until late 2015 and possibly into 2016.
With no pending crisis expected, thanks to central bank liquidity and a bias among Fed policymakers to keep interest rates low, the recent bull market for credit spreads is alive and well, supported by surging capital inflows, which have also helped U.S. stocks hit fresh highs. Bull markets have three phases. The first is the recovery, when prices are very depressed, the second is built on strong fundamentals, and the third is the speculative phase. Clearly, the Fed is increasingly risking the possibility of allowing the U.S. economy to overheat. Given its preoccupation with reducing unemployment while tolerating an increase in inflation, the central bank is setting the stage to potentially drive markets to unsustainable valuations. Most likely over the course of the next 12 to 24 months we will enter the speculative phase of this market. But, the best profits of a bull market often come in the speculative phase, so investors should stay the course for now.
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Chart of the Week
U.S. Credit Shows Signs of Frothiness
Measuring how far current spreads to U.S. Treasuries have moved past ex-recession average spreads, we can place credit assets in quartiles of overvaluation. By this measure, Build America Bonds and AAA-rated municipal bonds are in the fourth, or highest, quartile of overvaluation while CCC-rated corporate bonds are in the third quartile of overvaluation. There are still pockets of value — Collateralized Loan Obligations, preferred stock and some investment-grade debt — but across the spectrum of fixed income, the level of overvaluation has increased dramatically over the last six to eight weeks.
QUARTILE OF OVERVALUATION BY ASSET
Source: Credit Suisse, Barclays, Bank of America Merrill Lynch, Gugggenheim Investments. Data as of May 30, 2014.
Economic Data Releases
U.S. Payrolls Report Shows No Surprises
- Non-farm payrolls were in line with expectations in May, with 217,000 jobs added. Gains were spread across a variety of industries.
- Hourly earnings grew 0.2 percent in May and the workweek was unchanged at 34.5 hours.
- The unemployment rate was unchanged at 6.3 percent in May due to an unchanged participation rate.
- Initial jobless claims rose by 8,000 for the week ended May 31, up to 312,000.
- The JOLT survey showed job openings surged in April by the most in over a year, reaching the highest since September 2007.
- NFIB small business optimism increased more than expected in May to reach a six and a half year high of 96.6.
Euro Zone Data Strengthens, Chinese Exports Accelerate
- Euro zone retail sales were stronger than expected in April, rising for a fourth consecutive month at 0.4 percent.
- German industrial production showed a small rebound in May, rising 0.2 percent.
- Germany’s trade surplus widened in April as exports increased 3.0 percent, the most in over two years.
- Industrial production rose for a third consecutive month in the United Kingdom in April, up 0.4 percent.
- The U.K. unemployment rate dropped more than expected in April to 6.6 percent, more than a five-year low.
- China’s HSBC services PMI was near record lows in May at 50.7, down from 51.4
- Chinese exports continued to accelerate in May, reaching 7.0 percent growth, the best since January.
- Consumer price inflation in China picked up in May, rising from 1.8 percent year over year to 2.5 percent as food prices rose more than 4 percent.
- Japan’s Economy Watchers Survey rebounded in line with expectations in the May index of current conditions, up to 45.1. The expectations index reached the highest level this year.
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