An exasperated President Harry Truman once said, “Give me a one-handed economist! All my economists say, ‘on the one hand…on the other.’” Financial markets today probably have a lot of investors wishing for one-handed guidance from a trusted source.
I am sensitive to this since I recently predicted a pullback in U.S. equities while also asserting that the bull market could go on for some time. I am known for my strong (even unpopular) views, so people might think I am talking out of both sides of my mouth when I say U.S. equities could correct further and U.S. equities are fairly priced and could move higher.
As I wrote earlier in the summer, we are nearing the speculative phase of this bull market. At such times, it is very hard to make blanket statements about being bullish or bearish. Decisions are nuanced and depend on whether you are a speculator or an investor. Fundamentally, a speculator invests thinking things will be more expensive tomorrow and an investor buys assets he or she expects will provide exceptional long-run returns.
Hand-wringing over a lasting U.S. equity market correction is rife, but our historical analysis indicates that recent market volatility may be just a passing storm. Equity market consolidations of the magnitude we experienced in early August are commonplace in bull markets, occurring every 61 trading days on average. The last downturn occurred in April, so the market was due for a drop. However, we expect stocks to reach new highs by year end.
My advice to long-term investors is that this is not the time to fall victim to panic and sell. While market swoons are unsettling, it is worth remembering that while the Dow Jones Industrial Average dropped 22.6 percent on October 19, 1987, stocks ended that year slightly higher than where they were at the start of the year. In the end, “Black Monday” was just a temporary blip in the great bull run of the 1980s.
Lower Interest Rates
In contrast to others, I do not believe that U.S. interest rates will ratchet up in the near future. The likelihood that we are going to have a sudden, ugly increase in interest rates seems fairly remote for now. As for the long-run, the consensus view of interest rates normalizing will eventually come true. The problem with that thinking may lie in the definition of “long-run.” As John Maynard Keynes wrote in “A Tract on Monetary Reform” in 1923: “In the long-run we are all dead.”
A few weeks ago, for example, I was at a meeting of prominent investors where nearly everyone held the view that rates must normalize. I sat there listening, and thought, “Normalize to what?” As my fellow investors shared forecasts for forward rates and everything else, at one point I remarked that people are flattering the Fed, giving it too much credit for why long-term interest rates are where they are today.
What I mean by this is that when I look around the world and consider what is going on, it is hard to argue that U.S. 10-year Treasuries with yields hovering near 2.4 percent are unattractive compared to 10-year Japanese government bonds yielding close to 50 basis points. German 10-year bunds are yielding a historic low of just 1 percent with the Treasury/bund spread as wide as ever. Even in troubled Spain, benchmark borrowing costs have recently dipped below 2.5 percent — their lowest yield since 1789. Add to that the perception that both the yen and euro are seemingly a one-way bet toward depreciation and it is reasonable to expect that international capital will continue flowing toward the United States, pressuring U.S. Treasury yields down as quantitative easing draws to an end.
Most investors can agree that loose monetary policy and quantitative easing have caused overvaluation in some spheres of U.S. credit. Even U.S. Federal Reserve Chair Janet Yellen has said that some leveraged credit is showing signs of frothiness. But the palpable fear that the Fed’s eventual hiking of short-term interest rates will prompt a general upward shock in interest rates and an abrupt repricing of credit risk and U.S. Treasuries is getting overplayed and too much attention. The reality is that with international demand for U.S. Treasuries likely to increase and the size of incremental U.S. government borrowing expected to decline because of shrinking federal budget deficits, 10-year U.S. Treasury yields could move lower to the range of 2.0 to 2.25 percent.
Markets do not move in straight lines, so yields could retrace to 2.5 percent in the near term after breaking out as low as 2.35 in early August. Ultimately, as rates head back toward 2 percent investors should use the rally to reduce interest rate risk.
The article herein is for informational purposes only and should not be considered as investment 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. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information. Past performance is not indicative of future results.
Scott Minerd is Chairman of Investments and Global Chief Investment Officer at Guggenheim Partners