- Scott Minerd of Guggenheim Partners says the shape of the yield curve is one of the most valuable predictors of forward economic activity. He says the shape of the yield curve today indicates a recession in about one to one and a half years.
- He says if the Fed is forced to reduce rates because of an exogenous event, it would delay the recession but also make it more severe.
- Minerd says he is worried about excessive corporate leverage. When a downturn hits Minerd expects a trillion dollars or more of debt will have to be rerated.
- Minerd thinks equity valuations are pretty fair given where earnings growth is right now. So stocks could go higher in the next six to 12 months. He says this would fit the recession story, as stocks typically peak three to six before recession strikes.
- Minerd is also worried about the level of complacency in the market. He points to the downturn in November and December as an example of how crowded the exits get when things go south. He says investors need to realise they won’t be able to wait till the last minute to get out.
- He expects to see a real price adjustment when the real storm hits. For instance, he says we could see the yield double in some high yield assets.
- Minerd also weighed in on the Alexandria Ocasio-Cortez’s proposed 70% marginal tax rate on income above $US10 million. He argues the amount brought in by a this tax won’t make enough of a difference even if you assume people will pay it. But Minerd says historically when we have had high marginal tax rates wealthy people have sheltered their income.
Scott Minerd oversees $US265 billion in assets as global CIO of Guggenheim Partners. He sat down with Business Insider’s Sara Silverstein at the World Economic Forum in Davos, Switzerland. Following is a transcript of the video.
Sara Silverstein: What’s your outlook for the Fed?
Scott Minerd: Well, I think the Fed is going to pause here for an extended period at least into the second quarter or maybe even into the third quarter. The risks for them in taking a pause are pretty low. Inflationary pressure is waning at the moment because of energy price collapse. And ultimately, as the second half of the year comes around, I think we’ll start to see price pressure start to build again and then the Fed will start hiking rates again in the second half going into 2020.
Silverstein: And do you care about the shape of the yield curve?
Minerd: I think the shape of the yield curve is one of the most valuable predictors of forward economic activity. And the fact that we got extremely flat as the Fed raised rates is telling us that that’s probably leading us into a recession.
If you look at where the shape of the yield curve is today, historically we would expect a recession probably in about one to one and a half years as things evolve.
Silverstein: And is that when you expect us to have a recession?
Minerd: I think so. It all depends on what happens now. If the Fed is forced to reduce rates because of some other exogenous event that’s out there, then history shows us that that allows the expansion to continue. But it also allows the excesses to build up. And we already have a lot of excesses of the system, especially in the area of corporate leverage. So that would push the recession further out, but it would also make it more severe.
Silverstein: Where are you most worried about excessive corporate leverage?
Minerd: Well, media companies or telecom companies are are pretty overlevered. When you look at investment grade debt, there is a large percentage of investment grade debt that if you just took the rating agency standards for leverage should already be below investment grade. So when the downturn comes, I think that the rating agencies are going to have to do a broad rerating and we’re going to see an explosion in the number of fallen angels in probably maybe a trillion dollars or more.
Silverstein: And what do you think about where valuations are right now for equities?
Minerd: I think valuations are pretty fair given the earnings growth where we are right now. I think we probably have some room for multiple expansion. So I think over the next six to 12 months we could see stocks higher, but that would fit the recession story. Historically, stocks peak about three to six months before a recession. So if I’m right and we’re having a recession in 2020, we probably have a last hurrah left for stocks.
Silverstein: Is there any pocket that you think will do particularly well over that time period?
Minerd: Well, I think technology is going to bounce back and you’re starting to see it on a relative performance basis. So, I think that for speculators is a great place to be. For investors, it might be a good time to use the strength to lighten up.
Silverstein: And how are you positioning your portfolio?
Minerd: We really derisked a lot last year. So by the time we got to August and September we were basically out of our equity positions, out of high yield in accounts where we have that flexibility. And so, when the downturn came in the market we fared fairly well. Of course in the snap back, you know, we’re lagging. but, you know, again, I always fundamentally try to get people to understand – are you a trader or are you an investor? If you’re a trader, you should think about the next six months. If you’re an investor, you should think about the next five years. And, I think for the next five years it’s probably a good time to keep your powder dry and look for an opportunity in a couple of years.
Silverstein: Are there any market dynamics that worry you right now?
Minerd: Well, besides the overleverage in the corporate sector, which is the big concern I have. You know, I am concerned about the complacency. Even though, equities have gone as far as they have, investors are pretty willing to plow right back in as soon as they think that things have gotten safer.
In the downturn back in November and December, the most stark thing to me was how quickly the exits got crowded. It didn’t take much bad news to get to the point that sellers were clogging the exits. And in certain areas like leveraged loans or asset back securities prices would gap on a daily basis on virtually no volume. And so that basically is telling you that there was nobody ready to step in and buy in any size. And at the same time, there were a lot of sellers.
So I think the fact that people have made so much over the last decade on risk assets has caused them to become overly complacent and realise that you can’t wait till the last minute to make the adjustments to your portfolio.
Silverstein: And how is that going to play out when we have the next downturn that actually lasts and sticks?
Minerd: Well, I think when we get to that, we’re going to find out that these gap in markets that we’re a long way from where we can find any buyer in size. And so when you look at what happened, for instance, with bank loans in the fourth quarter and ETFs. The marginal seller was coming out of mutual funds and ETFs. The volume in terms of the total capital markets was pretty small. But yet the moves that we were getting were pretty big.
And so when we get to the point where we get the real storm, we’re so far away in pricing from where there’s value – to where investors that are basically being speculators are in – that it’s going to take a big price adjustment.
Silverstein: Do you have any idea of how much you expect that to be? How far away are we in some of these asset classes?
Minerd: Well, I think the high yield, for instance, that we could be six to eight percentage points away. So it wouldn’t surprise me to see a triple C bonds move out from where they’re trading today around 10% to something like 20%. Double B bonds are trading around four. They could be at eight. So, you know, it would be easy to double the yield in high yield.
Silverstein: There’s been a lot of debate about Alexandria Ocasio-Cortez’s proposed 70%t tax on all income above $US10 million. What are the economic implications of something like that?
Minerd: Well, you know, we’ve lived in these high tax regimes before. Go back to the 1930s, even the 1960s, we had very high marginal tax rates. When we cut tax rates in the 1980s we had a huge productivity boom. And the reason for that is that people who were wealthy spent a lot of time sheltering their income. And they drove investment into marginally less productive assets than they would if they just had free flexibility to put the money where they wanted to.
So, you know, the frightening thing about high marginal tax rates is that it leads us into a low productivity economy. And we have a lot of headwinds already in this country. For instance, the growth in the working age population is declining dramatically. If you layer on top of that high marginal tax rates, you could actually build an economy that has zero growth potential. And so I think policymakers have to be very careful when looking at putting high marginal tax rates on the rich.
And when you look at the revenue attached to it, if the Washington Post is right, even let’s assume that nobody makes a portfolio adjustment and they pay their marginal taxes. It’s about $US70 billion a year in an economy that’s running a trillion dollar deficit. I think we should probably have lower hanging fruit to find ways to address the real issues that are being brought up by some people in Washington like AOC or Bernie Sanders. There are real real issues to be addressed, but I think that we need to get more private sector incentive to address the issues rather than to necessarily weigh the private sector down with high taxation.
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