In her testimony before Congress this week, Federal Reserve Chair Janet Yellen was keen to escape the bonds of nuance and innuendo the market attaches to Fed language. Her emphasis was clear—the Fed will raise the federal funds rate when economic data support the move, a decision I foresee taking place during its Sept. 16-17 meeting. In the meantime, the period before the Federal Reserve raises rates is historically a great time to invest.
Over the past six tightening periods since 1980, the S&P 500 has returned 23.5 percent on average in the nine months prior to the first rate increase. Assuming the next tightening cycle begins at the Fed’s meeting in September, the nine-month period this time around began in mid-December. Since that time, the S&P 500 is already up more than 7 percent. Currently, a number of indicators, including my favorite, the New York Stock Exchange Cumulative Advance/Decline Line, show that the stock market is improving and can sustain its upward momentum.
The period prior to a rate hike has also been a favorable environment for corporate credit. High-yield bonds and bank loans have outperformed investment-grade bonds on average by 4.0 percent and 1.6 percent, respectively, in the nine months leading up to the start of the last three tightening cycles. Even after the Fed begins to raise rates, tightening of monetary policy does not necessarily lead to an immediate widening of credit spreads. During four of the last five tightening cycles (1983, 1986, 1994 and 2004), default rates continued to fall for nearly the entire tightening period and ultimately ended lower than they were when the Fed started to tighten. In the past four instances where the Fed began raising rates following an extended period of monetary accommodation, high-yield spreads tightened on three occasions. On average, high-yield spreads tightened for nine months after the first Fed rate hike in a cycle.
All of this, combined with positive historical performance prior to past rate hikes, leads me to believe that a positive environment for U.S. equities and credit will continue between now and the first Fed rate hike. Even after the Fed commences on what I expect will be a slow and steady march of tightening, fundamentals can remain constructive, especially for high yield, for some time.
Eventual Monetary Tightening Is Potential Positive for U.S. High Yield
Since 1986, of the four instances when the Fed began raising rates following an extended period of monetary accommodation, high-yield bond spreads continued to tighten on three occasions. Tightening of monetary policy does not necessarily lead to an immediate widening of credit spreads.
U.S. High-Yield Bond Spread Performance Following Fed Tightening
Source: Credit Suisse, Bloomberg, Guggenheim Investments. Data as of 2/25/2015. The range is generated by calculating the maximum and minimum values for all four previous cycles.
Economic Data Releases
U.S. Home Sales Slow While Prices Accelerate
- January existing home sales fell 4.9 percent, to an annualized pace of 4.82 million homes, a nine-month low.
- New home sales were largely unchanged in January, ticking down from 482,000 homes to 481,000. Sales in the Northeast region plunged 51.6 percent, likely reflecting poor weather.
- The S&P/Case-Shiller 20-City Home Price Index showed a faster annual growth rate in December, rising to 4.46 percent year-over-year, the first acceleration in over a year.
- The FHFA House Price Index rose 0.8 percent in December, the largest gain since May 2013.
- The Conference Board Consumer Confidence Index fell to 96.4 from 103.8 in February, but remained above 2014 levels despite the decline.
- Durable goods orders beat expectations in January, up 2.8 percent. Nondefense capital goods excluding aircraft rose for the first time since August.
- Initial jobless claims increased by 31,000 for the week ending Feb. 21, to 313,000.
- The Consumer Price Index fell into deflation in January, with prices down 0.1 percent from a year ago. However, core prices were stronger than expected, rising 0.2 percent from December and 1.6 percent year over year.
Continued Improvement in Euro Zone, China PMI Expands
- Economic activity strengthened in the euro zone in February according to the preliminary Purchasing Managers Indexes. Manufacturing ticked up to 51.1 from 51.0, and the services PMI rose to the highest since last July at 53.9.
- Euro zone economic confidence rose to 102.1 in February, the highest since last July.
- Germany’s manufacturing PMI was flat in the February preliminary reading, remaining in expansion at 50.9. The services PMI rose to a five-month high of 55.5.
- Germany’s IFO Business Climate Index inched up in February to 106.8 from 106.7. Expectations rose slightly while the current assessment fell.
- Germany’s GfK Consumer Confidence Index increased from 9.3 to 9.7 in the March survey, the highest since 2005.
- February preliminary PMIs in France were mixed, with manufacturing unexpectedly falling to 47.7 from 49.2 and services jumping to the highest since 2011 at 53.4.
- U.K. retail sales were weaker than expected in January, falling 0.3 percent. Sales excluding autos were down 0.7 percent.
- China’s HSBC manufacturing PMI rose back into expansion in February, up to 50.1 from 49.7.
Important Notices and Disclosures
The New York Stock Exchange Advance/Decline Line (NYSE breadth) is calculated by taking the difference between the number of advancing and declining stocks in the equity index.
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.