Global CIO Commentary by Scott Minerd
The liquidity preference theory, originally described by John Maynard Keynes in his General Theory, suggests that interest rate levels are determined by the demand for money. During times of high uncertainty, individuals and businesses exhibit greater demand for liquid assets, primarily cash and cash equivalents.
As uncertainty comes out of the system, pent-up cash balances need to be deployed. Considering how cheap some stocks are, the size of companies’ cash balances, and the impressive performance of the below-investment grade lending market, there is now a possibility of a resurgence in buy-outs and M&A-driven consolidation as private equity investors and corporate entities “put their money to work.”
The recent increase in the issuance of covenant-line loans – that is, loans with less stringent restrictions on collateral and payment terms for borrowers – can be interpreted as a harbinger for higher volumes of leveraged buy-outs, in particular. The history of covenant-lite loans is traceable to investments by private equity groups. The return of LBOs and M&A activity would generally provide support for equity prices, which is something for all investors to note.
Economic Data Releases
The Recovery in U.S. Housing Continues and Leading Indicators Grow at the Fastest Pace in Seven Months
U.S. data released last week indicated further recovery in the housing market. In September, housing starts were up 15% from August and both housing starts and permits reached their highest levels since July 2008. Existing home sales were 4.75 million in September, down from 4.83 million in August, but still the second highest monthly reading since June 2010.
Initial jobless claims increased to 388,000 last week, in line with the recent trend following the previous week’s surprising low of 342,000. The Philadelphia regional manufacturing index was 5.7 in October, the first positive reading (indicating expansion) after five consecutive negative prints in the previous months. The Leading Economic Index grew by 0.6% MoM in September, the strongest growth since February, led by robust gains in building permits, interest rate spreads, and equity prices.
Spanish Housing Woes Plod on While China’s Reported Data is Better Than Expected
Last week’s data from Europe was mixed. Spanish home prices fell 2.4% QoQ in 3Q, the 18th consecutive quarter of decline. U.K. retail sales grew at the fastest pace in four months. The U.K.’s unemployment rate also decreased to 7.9% in August, a 14-month low. Both industrial orders and industrial sales in Italy rose in August, the second consecutive month of increase for both.
In Asia, China reported that its economy grew 7.4% YoY in 3Q, the seventh consecutive quarter of slowing growth. However, on a quarterly basis the economy grew 2.2% from 2Q, the fastest pace in four quarters. Both Chinese industrial production and retail sales rose faster than expected in September. Meanwhile, fixed asset investment in China grew 20.5% YoY in the first nine months of this year, the strongest cumulative growth in half a year. In Japan, September’s trade balance reached -¥558.6 billion, the third consecutive month of deficit, driven by a 10.3% YoY plunge in exports.
Chart of the Week
The NYSE Cumulative Advance/Decline Line vs. Dow Jones Industrial Average Index
The New York Stock Exchange (NYSE) Cumulative Advance / Decline Line (Breadth) is one of the best leading indicators for the stock market. The indicator is built by taking the difference between the number of advancing and declining stocks. It has historically tracked closely with the Dow Jones Industrial Average Index and successfully predicted the bottom of the stock market in March 2009.
In the past week, the Cumulative Advance / Decline Line for the NYSE has reached an all time high surpassing the previous peak set in September 2012. In contrast, U.S. equities have lagged in their recovery from their recent bottom. This suggests that there is momentum for equities to rise further, indicating they may make new highs over the next 3-6 months.
Source: Bloomberg, Guggenheim Investments. Data as of 10/19/2012.
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