Sunny with a Chance of Turbulence

Global CIO Commentary by Scott Minerd

It seems summer brings out the sunny disposition in everyone. Despite the fact that returns across U.S. investment categories are pretty dismal year to date, markets are pricing optimistically and it seems the sunshine has brought growth back to the U.S. economy. Recent data from the Bureau of Labor Statistics showed a 280,000 increase in employment in May. Additionally, building permits rose 11.8 percent in May, better than the 3.5 percent decline forecast by economists, while the pace of existing home sales hit its fastest rate since late 2009. Taking everything into account, the likelihood that the U.S. economy will suffer a recession in the next year or two would appear to be extremely remote.

Still, seemingly isolated events could yet sour the mood. Since the euro crisis erupted back in 2010, the possibility of a “Grexit” has been a recurring issue. A number of commentators have painted the possibility of a Greek exit from the euro zone as the equivalent of a Lehman Brothers-style event, a view I’m not so certain is correct. With that said, seemingly minor occurrences have in the past set the stage for larger economic events, such as the collapse of the Thai baht, a seemingly contained event that ultimately proved to be the first domino to fall in the 1997 Asian crisis. While we cannot discount the consequences that a Greek exit could potentially herald, I believe a solution to paper over this seemingly never-ending crisis is likely to calm markets in the near term.

As for developments at the Federal Reserve, while some commentators have suggested that the Fed is leaning toward December, I can see no reason why the Fed would consider delaying a rate rise beyond September. Either way, I don’t think it matters: The bottom line is that a rate hike is coming. Personally, I consider the bond market to be in fairly good shape and capable of handling the beginning of “normalization” without a rerun of the 2013 taper tantrum, but only time will tell.

Lastly, despite the generally positive environment, it disturbs me how low returns have been across almost every asset class year to date. This tells me that markets may be getting fully priced for the near term, and that investors have already placed their bets on how they see major events of the day playing out. With all the chips on the table, new market inflows are likely needed in order to push prices higher, but I don’t envision significant inflows occurring until the fourth quarter. As evidence, the S&P 500 has not had a weekly move of more than 1 percent in either direction in two months, which is the longest such streak in over two decades. During this period, breadth has broken down in a meaningful way. For now, it doesn’t appear that investors are being compensated for the risks they are taking.

Despite poor year-to-date performance, the majority of forecasters have yet to alter their year-end S&P 500 price targets. In fact, the dispersion around analysts’ predictions is as tight as it’s been since 2009. This tells me the market doesn’t really feel like there’s a lot of uncertainty, which is concerning, because such high levels of complacency usually foreshadow some form of financial accident. I am not talking about a financial crisis, or a recession—we certainly have no indications of either yet—but there have been a number of periods of prolonged expansion where complacency climbs high and we wound up in an extremely turbulent period. Think about 2011, when there was a severe summer pullback in U.S. equities. Similar to today, at that time investors had basically put their bets on the fact the recovery was in place, and that stocks were going higher. Those bets turned out to be correct, but only after we narrowly avoided a 20 percent pullback.

With complacency as high as it is today, I fear we could be in for meaningful turbulence this summer. For this reason I would encourage investors to consider accumulating cash reserves or Treasuries in order to insulate themselves against any potential summer squalls during the next few months.

Economic Data Releases

U.S. GDP Revised Up in Final Estimate; Consumer Spending Records Fastest Growth in Nearly Six Years

• First-quarter GDP was revised up in the final estimate, but was still negative at -0.2 percent annualized. Better consumer spending helped revise the growth number upward.
• Existing home sales beat expectations in May, rising 5.1 percent to an annualized pace of 5.35 million homes. The percentage of first-time buyers rose to 32 percent.
• New home sales increased 2.2 percent in May, up to 546,000 after a positive revision to April’s data.
• Durable goods orders, excluding transportation, met expectations in May, up 0.5 percent. Nondefense capital goods orders excluding aircraft rose 0.4 percent, missing expectations after falling in April.
• The Federal Housing Free Agency House Price Index rose 0.3 percent in April, matching the previous month’s gain.
• Personal spending jumped 0.9 percent in May, a stronger showing than the 0.1 percent gain in April and ahead of market expectations of a 0.7 percent increase.
• Personal income climbed by 0.5 percent in May, matching the upwardly revised increase seen in April.
• In the 12 months through May, the personal consumption expenditures (PCE) price index rose 0.2 percent. The core PCE price index, excluding food and energy, rose 1.2 percent in the 12 months through May.

Euro Zone PMI Data Releases Continue to Point toward Growth

• Euro zone consumer confidence was unchanged in the initial June survey, remaining at -5.6.
• China’s HSBC manufacturing purchasing managers index (PMI) improved in June, but remained in contraction at 49.6.
• The euro zone manufacturing PMI showed a slight acceleration in activity in June, rising to 52.5 from 52.2. The services PMI rose to 54.4, a more than three-year high.
• Germany’s manufacturing PMI was better than forecast in June, rising to 51.9 vs. expectations of 51.2. The services PMI also rebounded after declining for the past two months.
• The French manufacturing PMI returned to expansion in June at 50.5, the highest reading in 14 months. The services PMI also made a multi-year high.
• Germany’s IFO Business Climate Index fell more than forecast in June, with both the current assessment and expectations worsening.

VIDEOS AND PODCASTS

 

2022’s Upside: The Fed Has Put the Income Back in Fixed Income

Anne Walsh, Chief Investment Officer for Fixed Income at Guggenheim Investments, joined Asset TV to discuss macroeconomic conditions, risk, and relative value in the bond market.

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2022’s Upside: The Fed Has Put the Income Back in Fixed Income

 

Macro Markets Podcast Episode 26: Mortgage-Backed Securities, Structured Credit, Market Liquidity

Karthik Narayanan, Head of Securitized for Guggenheim Investments, discusses value in the residential mortgage-backed securities market and other ABS sectors. Anne Walsh, Chief Investment Officer for Fixed Income, answers a listener question on liquidity. Jerry Cai, an economist in our Macroeconomic and Investment Research Group, brings the latest on the labor picture and an update on China.

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Macro Markets Podcast: Episode #26