Guggenheim Investments
10 Macro Themes for 2018
January 2018
10 Macro Themes for 2018 This collection of charts presents 10 of the macroeconomic trends we believe are most likely to shape the investment environment in 2018.
Investment Professionals Scott Minerd Chairman of Investments, Global CIO
1.
Tax Reform Will Boost Growth But May Not Save the GOP Majority
2.
The Unemployment Rate Will Fall to 3.5% or Lower
Macroeconomic and Investment Research Group
3.
Wage Growth Will Accelerate as the Labor Market Overheats
4.
Core Inflation Will Rise Modestly as the Economy Strengthens
Brian Smedley Group Head, Senior Managing Director
5.
The Fed Will Hike Four Times as it Overshoots its Employment Mandate
Maria Giraldo, CFA Director
6.
Central Banks Will Steadily Turn Off the Liquidity Taps
Paul Dozier Director
7.
Recession Risk Will Grow as Fed Policy Becomes Restrictive
Matt Bush, CFA, CBE Vice President
8.
The Yield Curve Will Flatten as the Fed Keeps Hiking
9.
Stocks Will Rise Despite an Aging Business Cycle
10. Record Corporate Debt Levels Will Come into Focus
Ning Liu, CFA Senior Associate Margaret Kleinman Vice President
This document 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 authors 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. Please See Important Disclosures in Back of Presentation
2
Tax Reform Will Boost Growth But May Not Save the GOP Majority Presidential Approval vs. Party’s Change in House Seats During First Term Midterms 20
Change in President's Party's House Seats
W Bush '02 10
0
HW Bush '90 -10
A Loss of 24 Seats Flips Control to Democrats
Kennedy '62
Nixon '70 Carter '78
-20
Eisenhower '54 Reagan '82
-30
-40
-50
Current Trump Approval
Clinton '94
-60
-70 30%
Obama '10
35%
40%
45%
50%
55%
60%
President's Approval Rating at Midterm Election
▪ Midterm elections tend to be challenging for first-term presidents, with the number of seats lost (or won) closely tied to the president’s approval rating. ▪ Based on President Trump’s current approval rating, the 2018 midterms do not look promising for House Republicans, who can only afford to lose 23 seats to retain their majority. ▪ Knowing these dynamics, Republicans passed tax reform to try to boost incomes before the election. Whether the passage of the tax reform bill will be sufficient to save the GOP’s House majority is in doubt.
▪ Tax reform will be a modest net positive for the economy, boosting real GDP growth by between 0.2 and 0.5 percentage point in the near 65% term, but it comes as the labor market is already on track to overheat.
Source: The American Presidency Project, U.S. House of Representatives, Office of the Clerk, Guggenheim Investments. Trump approval rating as of 12.22.2017.
Please See Important Disclosures in Back of Presentation
3
The Unemployment Rate Will Fall to 3.5% or Lower Unemployment Rate and University of Michigan Survey Derived Unemployment Forecast Unemployment Rate
Consumer Expectations for Unemployment Rate (6M Lead)
11%
1E-45
10% 8E-46
9%
8%
Guggenheim Projection
▪ The unemployment rate has fallen by 0.7 percentage point over the past year, and now stands at 4.1 percent, well below its estimated natural rate. ▪ Historically, consumers have done a fairly good job of predicting future changes in the unemployment rate, and recent readings point to further declines.
6E-46
7% 6% 4E-46
5% 4% 2E-46
3% 2% 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017
0
▪ With job growth likely to continue to run above the sustainable rate of labor force growth (75,000– 100,000 per month), we expect unemployment to fall to 3.5 percent by the end of 2018, meaningfully below the Fed’s forecast of 3.9 percent. ▪ In response, the Fed will deliver four rate hikes to cool a labor market that will have overshot the Fed’s “maximum sustainable employment” mandate.
Source: Haver Analytics, Guggenheim Investments. Data as of 11.30.2017 for unemployment, 12.8.2017 for Consumer Expectations.
Please See Important Disclosures in Back of Presentation
4
Wage Growth Will Accelerate as the Labor Market Overheats NFIB Small Business Survey: Single Most Important Problem* and Atlanta Fed Median Wage Growth Tracker Single Most Important Problem = Labor Quality (LHS)
Atlanta Fed Median Wage Growth (9M Lag, RHS)
25%
6%
20%
5%
15%
4%
10%
3%
5%
2%
0% 1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
▪ With the unemployment rate at a 17-year low, a variety of other indicators also point to a tight labor market. ▪ One such indicator comes from the NFIB Small Business Optimism Survey, where respondents increasingly report that their “single most important problem” is a lack of qualified workers. ▪ Wage growth has been sluggish, but with labor shortages becoming more widespread, wage growth will accelerate in 2018 as businesses try to attract and retain workers.
1%
Source: Haver Analytics, Guggenheim Investments. Data as of 11.30.2017. *Note: Represents percent of respondents citing labor quality as the single most important problem.
Please See Important Disclosures in Back of Presentation
5
Core Inflation Will Rise Modestly as the Economy Strengthens Real Final Sales to Private Domestic Purchasers and Core Consumer Price Index (CPI) Real Final Sales to Private Domestic Purchasers, YoY% (6Q Lead, LHS)
Core CPI, YoY% (RHS)
10%
3.1% Real Final Sales to Private Domestic Purchasers = Consumption + Fixed Investment
8%
2.8%
6%
2.5%
4%
2.2%
2%
1.9%
0%
1.6%
-2%
1.3%
-4%
1.0%
-6%
0.7%
-8% 1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
▪ One of the most surprising macro developments in 2017 was the drop in U.S. core inflation, with core CPI falling from 2.3 percent year-overyear in January to 1.7 percent in November. ▪ However, inflation is a lagging indicator. The drop in 2017 partly reflects the growth slowdown that occurred in late 2015/early 2016, as core inflation has historically lagged private sector domestic economic activity by six quarters. ▪ Growth rebounded in 2017, and we expect that it will accelerate further in 2018. As such, core inflation should return close to the Fed’s 2 percent target by the end of 2018.
0.4%
Source: Haver Analytics, Guggenheim Investments. Data as of 9.30.2017.
Please See Important Disclosures in Back of Presentation
6
The Fed Will Hike Four Times as it Overshoots its Employment Mandate ▪ Markets are pricing in about two Fed rate hikes in 2018, while the FOMC currently projects three.
Dual Mandate Shortfall and Federal Funds Target Rate Combined Dual Mandate Shortfall 10%
Fed Funds Target Rate Unemployment Too High and/or Inflation Too Low
8% Guggenheim Projection: Four Hikes in 2018 6%
▪ We expect four hikes in 2018 as inflation rises toward the Fed’s 2 percent goal and the unemployment rate falls further below the Fed’s definition of full employment (4.6 percent). ▪ Moreover, financial conditions remain highly accommodative, giving the Fed further room to raise rates, and fiscal stimulus will likely give the economy an additional boost.
4%
2%
0%
-2% Unemployment Too Low and/or Inflation Too High
Guggenheim Projection: 1.9% Core PCE Inflation, 3.5% Unemployment
▪ In keeping with historical precedent, the Fed will steadily tighten in order to cool the overheating economy and avoid a spike in wage or price inflation.
-4% 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019
Source: Haver Analytics, Congressional Budget Office, Guggenheim Investments. Data as of 11.30.2017. Combined dual mandate shortfall adds the deviation of core personal consumption expenditures (PCE) inflation from the Fed's 2 percent objective and the deviation of the unemployment rate from the CBO's estimate of the natural rate of unemployment. Positive values indicate that unemployment is too high and/or inflation is too low; negative values indicate that unemployment is too low and/or inflation is too high.
Please See Important Disclosures in Back of Presentation
7
Central Banks Will Steadily Turn Off the Liquidity Taps ▪ In 2018, some central banks will ramp down asset purchases while others allow holdings to run off.
Net Monthly Central Bank Purchases of Securities ($billions) (Includes Fed, European Central Bank, Bank of Japan, and Bank of England) Actual
Guggenheim Projection
▪ This dynamic will result in the withdrawal of a significant bid in fixedincome markets, with secondary effects spilling over into other asset classes.
$225 $200 $175
▪ For the Fed, during all of 2018 about $380 billion will run off.
$150 $125
▪ The ECB will reduce monthly purchases from €60 billion to €30 billion ($74 billion to $34 billion) in January until September 2018, and will probably wind down QE by the end of 2018.
$100 $75 $50 Fed runoff + ECB tapering + BoJ stealth tapering
$25
$0 -$25 2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
▪ The BoJ has been “stealth tapering” its target purchases of ¥80 trillion per year, or $60 billion per month, but has recently bought as little as $35 billion per month as 2019 it focuses on the 0 percent 10-year yield target. ▪ The BoE will continue to maintain the size of its holdings.
Source: Guggenheim Investments, Haver Analytics, Federal Reserve Bank of New York. Data as of 9.30.2017. Note: Assumes constant exchange rates. Quarterly averages of monthly figures.
Please See Important Disclosures in Back of Presentation
8
Recession Risk Will Grow as Fed Policy Becomes Restrictive ▪ While our 2018 economic outlook is positive, we are heading into the late stages of the business cycle.
Model-Based Recession Probability Next 6 Months
Next 12 Months
Next 24 Months
100%
1E-78
90% 80%
8E-79
70% 60%
6E-79
50% 40%
4E-79
30% 20%
2E-79
10% 0% 1984
0
1987
1990
1993
1996
1999
2002
2005
2008
2011
2014
2017
▪ Seeing an overheating labor market and rising inflation, the Fed will raise rates into restrictive territory, leading to an eventual recession. ▪ Our Recession Probability Model, which integrates several cyclical indicators, would have successfully signaled each recession going back to 1960. ▪ We expect that by the end of 2018 our model will signal a 30 percent probability of a recession in the next 12 months and a 60 percent probability within the next 24 months. ▪ By the end of 2018 investors should be positioned more defensively, as downside risks for equity and credit markets will grow in 2019.
Hypothetical Illustration. The Recession Probability Model is a new model with no prior history of forecasting recessions. Actual results may vary significantly from the results shown. Source: Haver Analytics, Bloomberg, Guggenheim Investments. Data as of 9.30.2017. Shaded areas represent periods of recession.
Please See Important Disclosures in Back of Presentation
9
The Yield Curve Will Flatten as the Fed Keeps Hiking ▪ As the Fed raises interest rates, we expect yields at the short and intermediate sectors of the Treasury curve to rise.
3 Month – 10 Year Treasury Yield Curve (basis points) Leading up to a Recession in Five Comparable Prior Cycles Range of Prior Cycles
Current Cycle
Average of Prior Cycles
400
▪ At the same time, the market will recognize signs of an aging business cycle, which will help to limit increases in 10–30 year yields.
300
▪ The result will be a continued flattening of the yield curve, which has historically been a reliable indicator of recession risk.
200
100
▪ Having observed similar yield curve behavior in past tightening cycles, our analysis shows that the current slope of the yield curve is consistent with periods when only 22 months remained until the onset of a recession.
0
-100
-200
-48
-42
-36
-30
-24
-18
-12
-6
0
Months Before Recession Start
Source: Haver Analytics, Guggenheim Investments. Data as of 12.31.2017. Includes cycles ending in 1970, 1980, 1990, 2001, and 2007. One basis point = 0.01 percent.
Please See Important Disclosures in Back of Presentation
10
Stocks Will Rise Despite an Aging Business Cycle S&P 500 Index, Cumulative Percentage Change Leading up to a Recession in Five Comparable Prior Cycles Range of Prior Cycles
Average of Prior Cycles
Current Cycle
40%
▪ Our analysis indicates that the next recession will occur around the end of 2019, but history suggests that there is plenty of upside remaining in equities. ▪ Historically, the S&P 500 has rallied by 16 percent, on average, in the penultimate year before the recession.
35% 30%
25%
▪ This suggests that the S&P 500 will make new highs in 2018 before turning lower in 2019.
20% 15% 10% 5% 0% -5%
-10% -15%
-28
-24
-20
-16
-12
-8
-4
0
Months Before/After Recession Start
Source: Haver Analytics, Guggenheim Investments. Data as of 12.31.2017. Includes cycles ending in 1970, 1980, 1990, 2001, and 2007. Past performance does not guarantee future results.
Please See Important Disclosures in Back of Presentation
11
Record Corporate Debt Levels Will Come into Focus ▪ Although we expect stocks to perform well in 2018, attention will increasingly turn to growing credit risks.
Ratio of U.S. Nonfinancial Corporate Liabilities to GDP and Average Investment-Grade Corporate Bond Yield Nonfinancial Corporate Liabilities / GDP (LHS)
Average Investment-Grade Corporate Bond Yield (RHS)
100%
18.5%
95%
16.0%
90%
13.5%
85%
11.0%
80%
8.5%
75%
6.0%
70%
3.5%
65% 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
1.0%
▪ The ratio of U.S. nonfinancial corporate liabilities to GDP is nearing 100 percent, well above the previous record of 93 percent in 2001. ▪ This increase in corporate indebtedness has been fueled by a secular decline in corporate borrowing costs. ▪ Given current tight credit spreads, we believe investors are not being adequately compensated for the buildup in credit risk that will be exposed during the next recession. ▪ Investors should begin to upgrade the credit quality of their fixed income portfolios now despite the next recession being two years away.
Source: Haver Analytics, Guggenheim Investments. Data as of 9.30.2017. Corporate bond yields are based on Bloomberg Barclays Investment-Grade Corporate Bond Index, and are smoothed based on a three-month average of monthly data before December 1989, and a three-month average of daily data from December 1989 through current.
Please See Important Disclosures in Back of Presentation
12
Disclosures and Legal Notice Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Real Estate, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management. This material is intended to inform you of services available through Guggenheim Investments’ affiliate businesses. This material is distributed or presented for informational or educational purposes only and should not be considered a recommendation of any particular security, strategy or investment product, or as investing advice of any kind. This material is not provided in a fiduciary capacity, may not be relied upon for or in connection with the making of investment decisions, and does not constitute a solicitation of an offer to buy or sell securities. The content contained herein is not intended to be and should not be construed as legal or tax advice and/or a legal opinion. Always consult a financial, tax and/or legal professional regarding your specific situation. This material contains opinions of the author or speaker, but not necessarily those of Guggenheim Partners, LLC or its subsidiaries. The opinions contained herein 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. 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. No part of this material may be reproduced or referred to in any form, without express written permission of Guggenheim Partners, LLC.
Investing involves risk, including the possible loss of principal. 1Guggenheim
Investments total asset figure is as of 9.30.2017. The assets include leverage of $11.6bn for assets under management and $0.4bn for assets for which we provide administrative services. Guggenheim Investments represents the following affiliated investment management businesses: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Real Estate, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management. 2Guggenheim
Partners’ assets under management are as of 9.30.2017 and include consulting services for clients whose assets are valued at approximately $63bn. Š2018 Guggenheim Partners, LLC. All Rights Reserved. No part of this document may be reproduced, stored, or transmitted by any means without the express written consent of Guggenheim Partners, LLC. The information contained herein is confidential and may not be reproduced in whole or in part. CP-MACRO 0118 #31381
Forward Looking Statements. This discussion material contains forward-looking statements, which give current expectations of market activities and market performance. Any or all forward-looking statements in this material may turn out to be incorrect. They can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. Although the assumptions underlying the forward-looking statements contained herein are believed to be reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurances that the forward-looking statements included in this discussion material will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation that the objectives and plans discussed herein will be achieved. Further, no person undertakes any obligation to revise such forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
Guggenheim Partners
13
Guggenheim’s Investment Process Guggenheim’s fixed-income portfolios are managed by a systematic, disciplined investment process designed to mitigate behavioral biases and lead to better decision-making. Our investment process is structured to allow our best research and ideas across specialized teams to be brought together and expressed in actively managed portfolios. We disaggregated fixed-income investment management into four primary and independent functions—Macroeconomic Research, Sector Teams, Portfolio Construction, and Portfolio Management— that work together to deliver a predictable, scalable, and repeatable process. Our pursuit of compelling risk-adjusted return opportunities typically results in asset allocations that differ significantly from broadly followed benchmarks.
Guggenheim Investments Guggenheim Investments is the global asset management and investment advisory division of Guggenheim Partners, with $243 billion1 in total assets across fixed income, equity, and alternative strategies. We focus on the return and risk needs of insurance companies, corporate and public pension funds, sovereign wealth funds, endowments and foundations, consultants, wealth managers, and high-net-worth investors. Our 275+ investment professionals perform rigorous research to understand market trends and identify undervalued opportunities in areas that are often complex and underfollowed. This approach to investment management has enabled us to deliver innovative strategies providing diversification opportunities and attractive long-term results.
Guggenheim Partners Guggenheim Partners is a global investment and advisory firm with more than $295 billion2 in assets under management. Across our three primary businesses of investment management, investment banking, and insurance services, we have a track record of delivering results through innovative solutions. With 2,500 professionals based in more than 25 offices around the world, our commitment is to advance the strategic interests of our clients and to deliver long-term results with excellence and integrity. We invite you to learn more about our expertise and values by visiting GuggenheimPartners.com and following us on Twitter at twitter.com/guggenheimptnrs.
Guggenheim Partners
14