This Too Shall Pass

Global CIO Commentary by Scott Minerd

At Guggenheim, a key tenet of our investment process draws on the Nobel Prize-winning work of behavioral finance pioneer Daniel Kahneman. In his most recent book, Thinking Fast and Slow, Kahneman admonishes investors that “closely following daily fluctuations is a losing proposition.” I often honor this principle by reminding individuals that they would be better off checking their portfolios much less frequently (Kahneman recommends once a quarter, for example).

In the spirit of this Nobel laureate’s foundational work, investors closely following the recent daily convulsions in the financial markets could be prone to overreaction. It never ceases to amaze me how a few days of sell-off in the stock market—or a modest back-up in rates, for that matter—can have everybody talking about bear markets. Looking beyond the myopic churn and burn, the important macro indicators remain positive, and nothing has occurred to fundamentally alter our positive outlook for equities or credit.

In U.S. interest rates, generally speaking, the pattern since 2009 has been for Treasury yields to decline, only for a sell-off to ensue before conditions stabilize and rates test their previous lows. This is the pattern I believe we are witnessing play out now. The yield on the 10-year Treasury note declined in January by more than 50 basis points before rebounding in February. Today, with quantitative easing underway in the euro zone, the risk is that U.S. 10-year rates are headed back lower. Despite the recent back-up, and the incessant chatter around the Federal Reserve’s “patience,” or lack thereof, the near-term risk to U.S. rates is likely to the downside. Fixed-income investors would be wise to stay fully invested given the current backdrop.

Meanwhile in the euro zone, central bankers commenced their commission to buy sovereign debt despite concerns over the fact that some bonds eligible for QE are trading at negative yields. If the program is successful, investors should see a weaker euro, improved growth, a sustained uptick in lending to the non-financial corporate and household sectors, and an increase in future inflation expectations. Early indications are that QE is working as the European Central Bank intends—bond yields are dropping and the euro continues to depreciate, which is stimulative to growth. In the United States, it’s very likely that we will see more demand for U.S. Treasury securities as a result of these record low rates in Europe, thus keeping a cap on U.S. rates.

In equities, instability in the U.S. market has caused the S&P 500 and the Dow Jones Industrial Average to lose the ground they gained thus far in 2015, but I believe this downward movement is just a momentary blip. Breadth remains strong. Seasonal factors are strong. The bottom line is that in the near term I see very little risk for stocks, and credit also remains a compelling proposition for investors. The recent turmoil is a quintessential call for the wisdom of behavioral finance and principled, long-term investing. To quote an old, sage scripture, “this too shall pass.”

Economic Data Releases

U.S. Job Growth Exceeds Wall Street Expectations in Spite of Cold Weather

• Nonfarm payrolls beat expectations in February, rising by 295,000. Services sector gains were strong, while goods producing sectors saw job growth slow.
• The unemployment rate fell two-tenths of a percent to 5.5 percent in February, while the labor force participation rate fell back to 62.8 percent.
• Average hourly earnings were below expectations in February, rising 0.1 percent from January and 2.0 percent from a year ago. Weekly hours were unchanged.
• U.S. retail sales dropped 0.6 percent in February. Economists had forecast a rise of 0.3 percent after a decline of 0.8 percent in January. With gas and car purchases stripped out, sales fell 0.2 percent, missing expectations, which were for a 0.3 percent rise.

• The trade balance narrowed in January to -$41.8 billion, due in part to a lower petroleum deficit.
• NFIB Small Business Optimism was largely unchanged in February, inching up to 98.0 from 97.9. Plans to increase employment fell slightly while plans to increase wages had a small rebound.
• Job openings rose to the highest level in 14 years in January, reaching nearly 5 million. The level of quits also rose to a post-recession high

German Wage Growth Continues, Chinese Data Disappoints

• The annual rate of German hourly pay growth slowed slightly to 2.0 percent in Q4 from 2.3 percent in Q3. But recent falls in inflation pushed real pay growth up.
• German exports contracted 2.1 percent in January following December’s 2.8 percent gain.
• Industrial production in the euro zone shrank 0.1 percent in January compared to the previous month. On a year-over-year basis, industrial production gained 1.2 percent.
• French industrial production beat expectations for January, with a 0.4 percent rise from December. Analysts were expecting a 0.3 percent drop.
• Italian industrial production fell 0.7 percent in January, the first decline in four months.
• U.K. industrial production in January fell 0.1 percent month over month and rose 1.3 percent year over year.

• Japan’s Economy Watchers Survey beat expectations in February, rising to 50.1 from 45.6 in the current conditions index, with an eight-month high of 53.2 in the outlook index.
• China’s trade surplus grew to a record high of $60.6 billion in February, as exports surged 48.3 percent from a year ago and imports dropped 20.5 percent. These figures are skewed due to Lunar New Year effects.
• China’s Consumer Price Index inflation bounced back to 1.4 percent in February, up from 0.8 percent in January. The Producer Price Index fell further into negative territory at -4.8 percent year over year.
• Chinese retail sales in the first two months of this year rose 10.7 percent year over year, versus expectations of an 11.6 percent rise. On a cumulative basis, that is the slowest pace since 2004.
• Chinese industrial output in the first two months rose 6.8 percent year over year, versus expectations of a 7.7 percent rise. On a cumulative basis that is the slowest pace in six years.

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