Against this Rosy Backdrop

While bonds are still reasonably valued, yields have risen more than expected and seasonals appear to have turned against equities.

Global CIO Commentary by Scott Minerd

In the wake of last week's strong employment report and this week’s May retail sales growth of 1.2 percent, along with the upward revision to April’s retail sales data, the winter soft patch associated with heavy snows and cold temperatures is clearly behind us. As expected, the second quarter bounce back has taken hold. The uncertainty related to April retail sales and consumer spending most likely resulted from discretionary income being directed to pay tax bills among those benefiting from the surge of employment in 2014.

The rebound in U.S. growth is supported by continued employment and wage growth, and tailwinds from lower energy prices over the past 12 months. Growing household formation should continue to support housing activity as employment of the important 25-34 year-old demographic continues to gain momentum. Add a stable dollar and rebounding European economy into the mix, and even exports should help to keep U.S. growth on track.

Against this rosy backdrop, bond yields have risen more than I would have expected. Nevertheless, the 2.6 to 2.7 percent range should serve as fairly good resistance as an upper bound on 10-year Treasury rates. At current levels, bonds represent reasonable value even if the Fed were to begin raising rates later this summer.

History shows from the start of the last tightening cycle in 2004 that rates tend to fall after the first Fed move if market expectation is for slow, measured increases. Additionally, the work we have done indicates that long-term rates should top out in this cycle around 3.0 to 3.5 percent, most likely somewhere around two or three years from now. Investors who buy longer-term bonds during the current backup should be well compensated in the subsequent holding period with an opportunity to participate in any post-rate increase rally should the Fed move soon or in the event that the Fed delays action, as some expect.

As for stocks, the seasonals have turned against us. While there still appears to be significant headroom for additional increases of 20 percent or more over the coming few years, underlying breadth and divergences in key indicators such as the transport index seem to support delaying new purchases to later in the summer.

Thawing Economy Should Support Wage Growth

With the U.S. economy picking up momentum, employment and wage growth should continue to accelerate in the months ahead, providing a boost to consumer spending. While the average hourly earnings series, released with the payrolls report every month, has shown only a slight acceleration in wage growth, other measures are pointing to a faster pickup. The Employment Cost Index (ECI) showed wages and salaries growing at the best pace since 2008 in the first quarter of 2015, while the more volatile Employer Costs for Employee Compensation (ECEC), released this week, has surged over the past year to a growth rate of more than 4 percent.

Wages and Salaries, YoY% Change

Thawing Economy Should Support Wage Growth

Source: Haver Analytics, Guggenheim Investments. Data as of 6/11/2015. *Note: average hourly earnings data prior to 2007 is for production and nonsupervisory employees only.

Economic Data Releases

Retail Sales Confirm Rebound Is Underway

  • May retail sales showed a solid increase, up 1.2 percent. April sales were revised up to 0.2 percent growth. Sales excluding autos and gas were up 0.7 percent.
  • University of Michigan Consumer Sentiment improved in the initial June survey to 94.6 from 90.7, led by a better assessment of current conditions.
  • NFIB Small Business Optimism improved in May, with the index up to a five-month high of 98.3. Plans to hire and to raise wages were positive but little changed.
  • Job openings jumped in April to 5.376 million, the highest level since the survey began in 2001. Both the hire rate and quit rate declined slightly.
  • Initial jobless claims were little changed for the week ending June 6, up to 279,000 from 277,000 previously.
  • The producer price index rose 0.5 percent from a month earlier in May, putting the annual growth rate at -1.1 percent, up from -1.3 percent.
  • Import prices rose for the first time in nearly a year in May, up 1.3 percent.

Solid German Data, China Stabilizing

  • Euro zone industrial production missed expectations in April, rising just 0.1 percent after a 0.4 percent decline in March.
  • German industrial production rebounded 0.9 percent in April, following a decline of 0.4 percent the previous month.
  • Exports out of Germany were strong again in April, up 1.9 percent, the third straight month of gains.
  • French industrial production unexpectedly fell in April, down 0.9 percent, the first decline in five months.
  • The Consumer Price Index in France continued to increase in May, rising to a six-month high of 0.3 percent.
  • Industrial production in the U.K. increased for a third straight month, rising 0.4 percent in April.
  • Retail sales growth in China met expectations in May, ticking up to a rate of 10.1 percent from a year earlier.
  • Chinese industrial production showed a small acceleration in May, up to a three-month high of 6.1 percent year over year.
  • The CPI in China showed inflation at 1.2 percent year-over-year in May, down from 1.5 percent in April.
  • Producer prices in China fell 4.6 percent from a year earlier in May, the same rate as April.
  • Japan’s Economy Watchers survey showed only small changes in May, with current conditions falling slightly to 53.3 from 53.6.

(c) Guggenheim Partners


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