February 27, 2013 | By Scott Minerd, Global CIO
Investors can continue to expect more volatility in the periods ahead. Whether the cause is the hung Italian election, statements or actions by any of the world’s major central banks, or the looming sequester, the net effect is the same: heightened uncertainty from political noise. Despite markets becoming more susceptible to policy-related risk, investment fundamentals have not changed. On the other side of this noisy air pocket, asset prices are likely to continue to rise. Credit spreads will keep coming in, and the VIX, which rose from 13.7 to 19.2 to start the week, is likely to re-trace, which means the equity market should rise to fill the gap created over the last number of days.
One consequence of this temporary flight to safety will likely be a fall in interest rates. Treasury yields broke their recent uptrend, meaning the 10-year note could decline toward 1.6%, which is roughly 20 points off the low for 2012. If this proves to be the case, we will take back most of the increases that we have seen since last year’s bottom. Overall, a fall in rates will stimulate demand for housing and prove a net positive for the return of the virtuous economic cycle.
The long-term correlation between the equity earnings yield and 10-year government bond yields, often referred to as the “Fed model,” is widely used for equity valuations. Despite the recent rally in global equity markets, spreads between equity earnings yields and 10-year government bond yields in major advanced economies are still generally higher than their pre-2008 averages. This implies that equities should have room to grow further, as government bond yields remain at low levels owing to major central banks’ easing policies.
THE SPREAD BETWEEN EQUITY EARNINGS YIELDS AND 10-YEAR GOVERNMENT BOND YIELDS
Source: MSCI, Bloomberg, Guggenheim Investments. Data as of 2/26/2013. Please note: Equity indices are MSCI regional indices; index earnings are trailing 12-month based and have been adjusted to exclude negative earnings. *U.K., Germany, France, Italy, and Spain are used as a proxy for Europe.
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.
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