Global CIO Commentary by Scott Minerd
There is a fairly low chance U.S. interest rates will rise meaningfully in the near-term. Indeed, I expect yields will decline from the current level of about 2.7 percent on the 10-year U.S. Treasury note. U.S. housing activity stalls when interest rates reach 3 percent, and I maintain my view that there remains an absolute ceiling of between 3-3.5 percent for the 10-year Treasury.
The Fed has told us that its decision on slowing its program of quantitative easing (QE) will depend on economic improvement, and economic data has been and will likely continue to be mixed. The market, then, is driven by expectations about QE, but uncertain as to what indicator is most important. Having said that, however, there is one thing I can state with complete certainty: we will taper or we will not taper, and either path can lead to a bullish outcome.
If the Fed decides to taper its asset purchases, it will be because the U.S. economy is strengthening. A stronger economy translates into lower corporate default rates and tighter credit spreads. If the Fed does not taper, then the continued injection of liquidity into the economy will support prices for risk assets, and credit spreads will tighten.
Equities, as the first cousin of credit, face the same roadmap. If tapering occurs, then the economy is strengthening, and that should be good for earnings and also good for equities. Conversely, if tapering is delayed, all risk assets, including equities, will continue to be buoyed by QE’s added liquidity. International equities remain well-positioned for stronger gains and the recent reduction in the European Central Bank’s benchmark rate to an all-time low of 0.25 percent further enhances the outlook for European stocks.
U.S. Equity Valuations Not a Bubble Yet
The equity risk premium, measuring the excess return of equities over a risk-free rate, indicates that U.S. equities have not reached bubble levels. Falling from the extremely cheap level at 10 percent in September 2011, the S&P 500 equity risk premium now sits at 4.4 percent, above the historical average of 2.8 percent. With ongoing economic improvement and continued monetary accommodation from the Federal Reserve, the current bull market in U.S. equities, which started in March 2009, should still have room to run.
S&P 500 INDEX EQUITY RISK PREMIUM
Source: Bloomberg, Guggenheim Investments. Data as of 11/14/2013. *Note: The equity risk premium is calculated by subtracting the risk-free rate (real 10-year Treasury yield as a proxy) from the earnings yield of equities (S&P 500 earnings yield as a proxy).
Guggenheim Investments represents the investment management businesses of Guggenheim Partners, LLC ("Guggenheim"). Guggenheim Funds Distributors, LLC is an affiliate of Guggenheim.
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*Assets under management is as of 12.31.2018 and includes leverage of $12.4bn. Guggenheim Investments represents the investment management businesses of Guggenheim Partners, LLC ("Guggenheim"), which includes Security Investors, LLC ("SI"), Guggenheim Funds Investment Advisors, LLC, ("GFIA") and Guggenheim Partners Investment Management ("GPIM") the investment advisers to the referenced funds. Securities offered through Guggenheim Funds Distributors, LLC, an affiliate of Guggenheim, SI, GFIA and GPIM.
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