February 05, 2014 | By Scott Minerd, Global CIO
Today, economic fundamentals in the United States are as strong as they have been since 2011. One would expect, therefore, that bond yields would rise and equities would rally. Instead, recent turmoil in emerging market countries has led to lower Treasury yields and a sell-off in U.S. equities.
Now, with the 10-year Treasury yield sitting at about 2.67 percent, there is probably more risk that interest rates will decline further rather than rebound over the short-term. However, the window for bond prices to rise is limited, so selecting credits carefully is key. Over the longer term, improving economic fundamentals in the United States will ultimately drive interest rates higher.
The indicators that I typically follow do not suggest that we have established a major top in the U.S. stock market. The current sell-off feels more like a healthy correction, the first since the last major correction in 2011. I am somewhat surprised by the timing of the latest rout, given the typical seasonal strength in January and February, but the U.S. Federal Reserve is finally letting markets self-correct after years of intervention since the 2008 financial crisis. We will likely look back on this time as an opportunity to buy.
Historically, rising equity prices have been associated with falling bond prices (rising bond yields), as stronger economic fundamentals drove investors to stocks and away from bonds, and weaker economic growth produced the reverse. However, over the past few years, equity and bond prices began moving together as both markets were inflated by floods of liquidity from accommodative U.S. monetary policy, which distorted the traditional relationship. After tapering of quantitative easing by the U.S. Federal Reserve was first suggested in mid-2013, markets began returning to more normal correlations, driven not by expectations of continued quantitative easing, but by the economic outlook.
Source: Bloomberg, Guggenheim Investments. Data as of 1/31/2014.
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Risk assets will likely enjoy another rally while the Fed stays on hold, but the pause will only allow excesses to become more pronounced.
Should the mood this year at Davos prove once again to be a contra-indicator, this may be the signal that the economy is likely to re-accelerate soon and that the party in risk assets continues.
What would be a normal seasonal correction is turning into the worst December selloff in equities since the Great Depression.
Global CIO Scott Minerd and Head of Macroeconomic and Investment Research Brian Smedley provide context and commentary to complement our recent publication, “Forecasting the Next Recession.”
Anne Walsh, Chief Investment Officer for Fixed Income, shares insights on the fixed-income market and explains the Guggenheim approach to solving the Core Conundrum.
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