Global CIO Commentary by Scott Minerd
The U.S. economy is in the best shape out of any economy in the world, but it reminds me of a great business with a bad stock. Despite its underlying economic strength, I believe U.S. equity markets are likely to underperform those of less healthy economies in the long run. When I look around the world at economies that have many more problems than the United States, I see more upside potential for equity valuations and market performance in places like Europe, China and India.
Certainly, the United States is in a self-sustaining recovery—already the fifth-longest economic expansion since World War II. Despite noise this week around the 3.4 percent decline in durable goods orders, recent economic data releases continue to be positive: new home sales rose to a 6.5-year high and the Conference Board’s Consumer Confidence Index surged to 102.9 in January, the highest since August 2007. The U.S. economy remains the engine sustaining global growth, but when it comes to equity market valuations, a lot of the risk premia are out of the market.
One of my favorite macro-valuation tools is to compare total stock market capitalization to underlying gross domestic product (GDP). In the United States, this ratio is currently 134 percent, the highest level since the third quarter of 2003, the year this global comparison data became available. By the same measure, equity valuations in the euro zone, China and India are much lower. China’s equity market capitalization, for example, is 51 percent of its GDP, significantly below the previous high of 101 percent registered just prior to the global financial crisis.
As policymakers around the world introduce measures to reflate their economies and implement structural reforms to release growth potential, I wouldn’t be surprised to see Chinese, European, and Indian equities outperform U.S. stocks in the long run.
Switching to the bond market, I’ve been bullish since last fall that rates in the United States would decline to 2 percent or lower. In the near term, rates probably will fall further, but given that we’ve come more than 120 basis points since the beginning of January 2014 (as of yesterday’s close), it seems that the best part of the bull market in U.S. rates is over.
If it weren’t for quantitative easing in Europe and the deflationary shock coming out of oil, we would see U.S. rates meaningfully higher than they are today. With inflation likely to start picking up in the second half of the year, wage growth is likely to start showing strength due to increases in minimum wage (20 states increased minimum wage effective Jan. 1), and the prospect that the Federal Reserve will probably increase rates at some point in the second half of the year, the vulnerability to rates rising will increase as the year plays out.
This will mean tough sledding for most of the bond market, but it’s not necessarily bad news for the U.S. economy. Even if rates rise modestly and a lot of the juice leaves the equity markets in 2015, the underlying economy is just fine and will continue to be just fine.
Foreign Markets May Offer More Growth Potential
U.S. stock market capitalization as a percent of GDP is at its highest level since the third quarter of 2003, the year this global comparison data became available. By the same measure, equity valuations in the euro zone, China and India appear much lower. As central banks in those countries implement policies to reflate their economies and structural reforms take hold, stock markets in those countries may present more attractive opportunities in the long run.
Stock Market Capitalizations as a Percent of GDP
Source: Bloomberg, Haver, Guggenheim Investments. Market capitalization data as of 1/29/2015 and GDP data as of 12/31/2014 for the U.S., as of 9/30/2014 for India, the euro zone, and China.
Economic Data Releases
U.S. GDP Growth Slows on Trade and Investment
- Fourth quarter GDP was below expectations at 2.6 percent annualized. Consumer spending rose a robust 4.3 percent, while net exports subtracted a percentage point from growth. Business investment slowed while residential investment accelerated.
- The employment cost index, a closely watched measure of wage and compensation inflation, rose 0.6 percent in the fourth quarter, keeping the year-over-year rate flat at 2.2 percent.
- Durable goods orders unexpectedly fell 3.4 percent in December from the previous month, well below the market expectation of a 0.3 percent increase. Falling sales of the highly volatile civilian aircraft sector drove the decline. Excluding transportation productions, orders fell by 0.8 percent.
- The S&P/Case-Shiller 20-City Home Price Index registered a 4.3 percent year-over-year growth in November, in line with market expectations. The index grew by 4.5 percent in October.
- New home sales jumped by 11.6 percent to an annualized pace of 481,000 in December, the highest level in more than six years. The gain bodes well for the sector’s continued expansion in 2015.
- The Conference Board’s Consumer Confidence Index surged to 102.9 this month, up from December’s revised reading of 93.1. Lower energy prices and a six-year-low unemployment rate have boosted confidence in the U.S. economy.
- University of Michigan Consumer Sentiment inched down in the final January reading to 98.1, but remained at an 11-year high after the revision.
Deflation Continues in Europe, Japanese Data Improves
- The euro zone Consumer Price Index fell even more than expected in January, reaching -0.6 percent while core prices made an all time low of 0.6 percent.
- Euro zone economic confidence rebounded in the January reading, reaching a six-month high of 101.2.
- German inflation fell more than expected in January, with the CPI falling to -0.5 percent year over year.
- Germany IFO Business Climate Index rose to 106.7 this month from 105.5 in December, higher than the market expectation of 106.5. This is the third straight rise since October of last year.
- Germany’s GfK consumer confidence surprised to the upside in February, reaching 9.3, the highest reading since records began in 2005.
- U.K. quarter-over-quarter GDP growth recorded a 0.5 percent expansion in the fourth quarter, the slowest quarterly growth in 2014 and less than the 0.6 percent forecast by economists. Nevertheless, it represents the eighth straight quarterly expansion.
- Japan’s CPI held at 2.4 percent year over year in December, with prices excluding food and energy also unchanged at 2.1 percent.
- Industrial production in Japan increased 1.0 percent in December after falling in November.
- Japanese exports in December jumped by 12.9 percent on a year-over-year basis, reaching the highest level in six years. The stronger export growth, supported by a weaker yen, beat the market expectation of 11.2 percent.
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