February 06, 2013 | By Scott Minerd
“The current environment bears a number of similarities to 2004. Asset prices have recovered from the losses incurred in the preceding recession, and credit spreads are about where they were nine years ago. From 2004 to 2007, spreads came in as economic expansion continued. Along the way, there were several major setbacks, such as the period in 2005 when rates backed up severely. There is a risk that a similar period of volatility may occur again, however, spreads should continue to ratchet in, overall.
Also reminiscent of 2004, equity markets will continue to benefit from easy monetary conditions. With the recovery in corporate earnings now less robust, share prices in the U.S. are unlikely to rise as dramatically as they have over the previous three years. That said, investors can expect further domestic equity appreciation, with a possible gain of up to 35% for the Dow Jones Industrial Average by the end of 2015. Asian and European bourses appear as though they will outperform the U.S. in the years ahead. The trend of liquidity-induced multiple expansion in stocks and further credit spread tightening for certain areas of the fixed income market is unlikely to abate for as long as yields on 10-year Treasuries remain below 4%.”
Despite a temporary spike in 2005, the U.S. high-yield bond default rate has, historically, tracked the federal funds target rate closely, with a lag of approximately two years. Given the Federal Reserve’s efforts to maintain a low interest rate environment for an extended period of time, high-yield default rates should remain depressed, which is supportive of credit spreads.
Source: Credit Suisse, Bloomberg, Guggenheim Investments. Data as of 1/31/2013. *Note: The high-yield bond default rate is trailing 12-month based.
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