'Risk On' for Now

U.S. high-yield bonds, leveraged credit, and equities will likely outperform in the coming months, but there are obstacles ahead.

November 06, 2014    |    By Scott Minerd

Global CIO Commentary by Scott Minerd

U.S. economic data remain strong with the third quarter’s 3.5 percent GDP growth signaling that the economy is doing pretty well across the spectrum. Net exports were strong, unemployment has fallen much faster than expected, and consumer confidence is at seven-year highs. The fact that the government is contributing to GDP growth tells us that a major headwind for the economy—contracting government spending—has gone away, and I do not expect it to return.

Japan and Europe remain the train wrecks they were advertised to be. Interestingly, the slowdown in the euro zone is now concentrated at the core rather than on the periphery. As a result, we could soon witness a dramatic shift in the European political dynamic. If German politicians are worried about their own economy they will be much more willing to accept accommodative European Central Bank policies than if they are concerned about Italy.

Japan’s major increase in monetary accommodation surprised markets last Friday and came just days after the U.S. Federal Reserve ended its own quantitative easing program. The night before the so-called Halloween surprise, I was looking over some Japanese data and thought to myself that it was surely inevitable that Tokyo would increase accommodation and that doing it sooner rather than later would give them the added benefit of surprise. I never expected the announcement to come the very next day.

The takeaway from all this is that while the Fed has ended QE, the great global monetary expansion is far from over as other central banks take up the slack. The sell-off in U.S. high-yield bonds and leveraged bank loans during the third quarter has made for an attractive entry point, and while I expect to see some sort of consolidation in U.S. equities, the near-term risk is that stocks are headed higher.

I would caution that the current rally in U.S. equities has not been confirmed in the NYSE Cumulative Advance/Decline Line and investors would be well advised to monitor this closely. The United States will likely do very well in the next six months thanks to overseas policies, but there are obstacles ahead. As the U.S. dollar strengthens and without the support of the Fed’s asset purchases, the U.S. economy will be challenged heading into the second half of 2015 to sustain its growth based on employment and wage expansion. While it would be premature to draw conclusions beyond the first quarter of next year, for now, risk assets remain the place to be.

Can U.S. Equities Sustain this Rally?

Despite the Dow Jones Industrial Average high made on Nov. 6, the New York Stock Exchange Cumulative Advance/Decline Line remains 1.1 percent lower than its peak on Aug. 29. Historically, a persistent divergence between the DJIA and the Advance/Decline Line usually leads to a major correction in equities. Whether or not the Advance/Decline Line can catch up with the increase in equity prices over the next few weeks will determine whether the current rally is sustainable.

Cumulative NYSE Advance/Decline Line and the Dow Jones Industrial Average


Source: Bloomberg, Guggenheim Investments. Data as of 11/6/2014.

Economic Data Releases

Payroll Growth Steady as Unemployment Heads Downward

  • Non-farm payrolls increased by 214,000 in October, slightly under expectations of 235,000. However, October was the ninth consecutive month above 200,000.
  • The unemployment rate fell to 5.8 percent in October, even as the labor force participation rate inched up to 62.8 percent.
  • Average hourly earnings remained at 2 percent year over year, indicating little wage pressure. Average weekly hours ticked up to 34.6.
  • U.S. GDP, on first estimates, grew at a 3.5 percent annual rate in the third quarter, better than the 3 percent consensus expectation. Government defense spending and net exports boosted growth.
  • The ISM manufacturing index jumped to 59 in October from 56.6 in September, higher than the market expectation of 56.1. Of 18 industries, 16 reported growth.
  • The ISM non-manufacturing index decreased to 57.1 in October. While the new orders component fell slightly, the employment index reached a nine-year high.
  • The final reading of the October University of Michigan consumer sentiment index came in at 86.9, its highest level since July 2007.
  • The trade deficit widened to $43 billion in September, the largest in four months. Exports dropped 1.5 percent as global demand cooled.

Euro Zone Outlook Continues to Worsen

  • The euro zone’s inflation rate edged up to 0.4 percent in October, in line with expectations, but remains below the European Central Bank’s target rate for the 21st month in a row.
  • Euro zone retail sales were worse than forecast in September, falling 1.3 percent. The previous month’s figures were also revised downward.
  • Unemployment in the euro zone was stable in September at 11.5 percent.
  • Retail sales in Germany fell 3.2 percent month over month in September, far worse than expected and the biggest monthly decline since May 2007.
  • Germany’s industrial production rose 1.4 percent in September, but remained in negative territory on a year-over-year basis.
  • German exports rebounded strongly in September, up 5.5 percent after August’s 5.8 percent plunge.
  • French industrial production was unchanged in September, following a 0.2 percent decrease in August.
  • The U.K. manufacturing purchasing managers' index rose to 53.2 from 51.5, reaching its highest level since July.
  • U.K. industrial production rose 0.6 percent in September, the best month since February.
  • China’s official non-manufacturing PMI fell to 53.8 in October from September’s 54.0, the lowest level since January.
  • China’s HSBC services PMI fell to 52.9 in October from 53.5 in September.
  • Japan’s headline consumer price index unexpectedly ticked down to 3.2 percent in September, with core inflation also declining.


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