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Macro View

What the Fed's Rate Hike Means for Investors

December 17, 2015

Historically, both equities and fixed income have performed solidly in the initial years of Fed tightening cycles.

The Federal Reserve made history Dec. 16, finally raising the fed funds target range by 25 basis points to 0.25-0.50 percent after seven years at the zero bound. We anticipate a gradual pace of tightening, though not quite as gradual as the market is currently pricing in. We expect three 25 basis point hikes in 2016 and another three in 2017, with the next hike likely to occur at the March 2016 Federal Open Market Committee meeting. Our analysis suggests the terminal rate in this cycle will be in the range of 2.5–3.0 percent, below the Fed’s estimate of 3.5 percent, which should help to keep 10-year Treasury yields under 3 percent.

 


 

 

If history is a guide, equities typically experience an initial pullback of 5–10 percent in the months following the first rate hike in a tightening cycle. Historically, though, the S&P has ultimately performed well during recent tightening cycles, returning a cumulative 15 percent, on average, in the first two years of the last three tightening cycles. That being said, current valuations temper our return expectations—the ratio of U.S. equity market cap to GDP is near its historical peak, buoyed by historically low rates.

S&P Sectors Generally Positive Two Years From First Rate Hike

Average Cumulative Two-Year Total Return Following Start of Last Three Tightening Cycles

Emerging Market Valuations Look Attractive, but Risks Remain

Source: Bloomberg, Haver Analytics. Data as of 11.19.2015, based on the last three tightening cycles beginning in February 1994, June 1999, and June 2004. ©2015, Guggenheim Partners.

 

Fixed-income investors should also benefit—leveraged loans stand out as having delivered strong returns with much less volatility than the S&P 500 and Treasuries, on average, during previous periods when short-term rates were rising. Leveraged loans returned 5.8 percent on average in the first year of the last three Fed hiking cycles, higher than the S&P’s 4.9 percent. We believe the recent selloff in high-yield credit presents an attractive buying opportunity that will ultimately prove rewarding for patient investors.

U.S. Equity Market Has been Inflated by Low Rates

Ratio of U.S. Equity Market Cap to GDP vs 10-Year Treasury Yields Since 1960

Emerging Market Valuations Look Attractive, but Risks Remain

Source: Haver Analytics, Federal Reserve, Guggenheim Partners. Data as of 9.30.15. ©2015, Guggenheim Partners.

Economic Data Releases

Leading Economic Indicators Climb in November as Homebuilding Picks Up

  • In the 12 months through November, headline inflation rose 0.5 percent. Core inflation was up 0.2 percent from October. The annual core inflation rate quickened to 2 percent from 1.9 percent in October.
  • The index of U.S. leading economic indicators increased 0.4 percent in November, aided by an increase in home construction permits and higher stock prices. Economists had forecast an increase of 0.1 percent.
  • The latest Empire State Manufacturing Survey indicated a further decline in business activity in December. However, the pace of decline slowed from the previous month.
  • The pace of homebuilding in November increased 10.5 percent on the previous month. Building permits ticked up by 11 percent in November from October to an annual pace of 1.289 million.
  • Industrial output slipped 0.6 percent in November after a downwardly revised 0.4 percent decline in October. Economists had forecast industrial production slipping by 0.2 percent.
 

Euro Zone Data Points to Solid 4Q Performance as U.K. Unemployment Continues to Fall

  • The Euro Zone Manufacturing Purchasing Manager’s Index (PMI) rose to 53.1 from 52.8 in December, a 20-month high. The services PMI fell to 53.9 from 54.2.
  • Industrial production for October increased 0.6 percent month over month in the euro zone. This contrasted to a decline of 0.3 percent in September.
  • December’s reading of the German ZEW index of current economic sentiment came in at 55, ahead of economist’s expectations of 54.2 and a November print of 54.4. The expectations index increased to 16.1, up from 10.4 in November.
  • The Ifo Institute Index of the German business climate fell to 108.7. Economist had forecast no change the November print of 109.0.
  • At 0.1 percent year over year, the rate of inflation in the United Kingdom turned positive in November for the first time in four months.
  • The U.K. unemployment rate fell to 5.2 percent in the three months to October, a post-financial-crisis low.
  • On a year-over-year basis, Japanese exports fell 3.3 percent in November, versus expectations for a 1.6 per cent decline.

Important Notices and Disclosures

The ratio of stock market capitalization to GDP can give an indication of whether a market is undervalued or overvalued.

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. This article contains opinions of the author but not necessarily those of Guggenheim Partners or its subsidiaries. The author’s opinions are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC. ©2015, Guggenheim Partners. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.

The views and strategies described herein may not be suitable for all investors. Past performance does not guarantee future returns. The value of any investment may rise or fall over time. Investing involves risk, including the loss of principal. The content of this video is for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy, or investment product. The material should not be considered research nor is it intended to provide a sufficient basis on which to make an investment decision. Any opinions contained herein are not necessarily those of Guggenheim Partners, LLC or its subsidiaries and are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and nonproprietary research and other sources. This material has been provided by Guggenheim Investments which represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Real Estate, LLC, Transparent Value Advisors, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management.



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