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Preparing for the Next Credit Cycle

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Preparing for the Next Credit Cycle Guggenheim Partners Preparing for the Next Credit Cycle Brian Quinn Portfolio Specialist & Product Manager January 2020 For financial professional use only. Do not distribute to the public. 10 Macro Themes for 2020 • Household Net Worth Gains Will Support Consumption • Low Rates Will Underpin Housing Despite Valuation Concerns • The Pace of Fed Balance Sheet Expansion Will Slow • A Tight Labor Market Will Further Depress Corporate Profit Margins • Corporate Defaults Will Rise as Debt Burdens Weigh on Credit • Credit Rating Downgrades Will Add Headwinds to Business Investment • The Fed’s Soft Landing Theory Will be Tested • Consumer Confidence Will Hinge on the Health of the Labor Market • Historic Inequality Will Fuel Support for Unorthodox Policy Proposals • The 2020 Election Will Influence the Economy in an Unprecedented Way For financial professional use only. Do not distribute to the public. 2 Extending the Business Cycle Has the Fed Pulled Off a “Mid-Cycle Adjustment”? Fed Funds Target Rate 10% 9% 8% Historical evidence is mixed: Green=Yes Red=No 7% 6% 5% 4% 3% 2% 1% 0% 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Source: Guggenheim Investments, Haver Analytics. Data as of 10/31/2019. Shaded areas represent periods of recession. For financial professional use only. Do not distribute to the public. 4 Liquidity Driven Rally Has Fueled High Returns With High Valuations Equity and Corporate Credit Valuations vs. Total Returns YE 2018 YE 2019 Total Return Metric Pct Rk. Metric Pct Rk. 2019 Pct Rk. S&P 500 Price to Sales 1.9x 76.1% 2.4x 99.9% Price to EBITDA 10.0x 75.4% 12.1x 99.9% 31.5% 93% Price to Earnings 16.6x 21.9% 21.5x 75.2% Corporate Credit Spreads High Yield Corps 5.3% 35.7% 3.3% 79.2% 14.3% 84% IG Corps 1.5% 33.8% 0.9% 79.6% 13.4% 91% Note: S&P 500 refers to S&P 500 TR USD Index; High Yield Corps refers to the Bloomberg Barclays US Corporate High Yield Index; IG Corps refers to the Bloomberg Barclays US Corporate Investment Grade Index. Source: Bloomberg. 1/1/1996 to 12/31/2019. For financial professional use only. Do not distribute to the public. 5 1. Low Rates Will Underpin Housing Despite Valuation Concerns University of Michigan Consumer Sentiment Survey: Buying Conditions for Houses By Reason, Net % Balance Buying Conditions Due to Rates Buying Conditions Due to Prices 80% Good Time to Buy 70% 60% 50% 40% 30% 20% 10% 0% -10% Bad Time to Buy -20% 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 Source: Guggenheim Investments, Bloomberg, University of Michigan. Data as of 12.31.2019. Note: three-month moving average. For financial professional use only. Do not distribute to the public. 6 2. Household Net Worth Gains Will Support Consumption U.S. Household Assets and Liabilities, % of Disposable Personal Income Assets to Personal Income (LHS) Liabilities to Personal Income (RHS) 850% 140% 130% 800% 120% 750% 110% 700% 100% 650% 90% 600% 80% 550% 70% 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 2018 Source: Guggenheim Investments, Haver Analytics. Data as of 9.30.2019, estimates shown for Q4 2019. For financial professional use only. Do not distribute to the public. 7 3. The Pace of Fed Balance Sheet Expansion Will Slow Federal Reserve Assets, in USD Billions Coupon Securities Other Assets Repurchase Agreements (Repos) T-Bills $4,600 Guggenheim Forecast $4,400 $4,200 $4,000 $3,800 $3,600 $3,400 $3,200 2016 2017 2018 2019 2020 Source: Guggenheim Investments, Haver Analytics, Federal Reserve Board. Data as of 12.31.2019. Coupon securities include Treasury notes and bonds, Agency debentures, and Agency mortgage- backed securities. For financial professional use only. Do not distribute to the public. 8 And Added Money Supply May Deliver Slower Money Velocity Velocity Money Slower Deliver May Supply Money Added And Source: FRED as of 12/31/2019. 12/31/2019. of as FRED Source: M2 Money M2Supply Money Money / vs. NominalM2Velocity GDP M2 Money Supply / Nominal GDP 40% 45% 50% 55% 60% 65% 70% 75% 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 For financial professional use only. not Do distribute to the public. 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 1.3x 1.4x 1.5x 1.6x 1.7x 1.8x 1.9x 2.0x 2.1x 2.2x 2.3x M2 Money Velocity Money M2 9 But Monetary Stimulus is Having a Mixed Effect on Credit Demand Senior Loan Officer Survey: Net % of Banks Reporting Stronger Demand for Loans Commerical & Industrial Loans Residential Mortgages 80% 60% 40% 20% 0% -20% -40% -60% Recessionary Corporate Demand, but Mortgage Demand Surging -80% 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 2020 Source: Guggenheim Investments, Bloomberg. Data as of 11/04/2019. Shaded areas represent periods of recession. C+I loan demand is average for large firms and small/medium firms. For financial professional use only. Do not distribute to the public. 10 A Tight Labor Market Leaves Little Room for Further Expansion U.S. Unemployment Rate, with Months to Start of Next Recession After Full Employment Was Reached 11% 10% 9% 8% 7% 22 Mo. 35 Mo. 6% 25 Mo. 56 Mo. 31 Mo. 5% 32 Mo. 4% Full employment reached 3% 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 2014 2018 Source: Guggenheim Investments, BLS, Haver Analytics, Congressional Budget Office. Data as of 10/31/2019. Shaded areas represent periods of recession. For financial professional use only. Do not distribute to the public. 11 Despite a Tight Labor Market, A Cyclical Upturn in Inflation Is Unlikely Real GDP Growth vs Core CPI Inflation (6-Quarter Lag) 6% 3.00% Real GDP, YoY% (LHS) 5% 2.75% Core CPI, YoY%, 6 Quarter Lag (RHS) 4% 2.50% 3% 2.25% 2% 2.00% 1% 1.75% 0% 1.50% -1% 1.25% -2% 1.00% -3% 0.75% -4% 0.50% 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Source: Guggenheim Investments, Haver Analytics. Data as of 09/30/2019; Q4 2019 GDP data are estimated. Shaded areas represent periods of recession. For financial professional use only. Do not distribute to the public. 12 4. A Tight Labor Market Will Further Depress Corporate Profit Margins U.S. Corporate Pre-Tax Profits* and Unit Labor Costs Corporate Profit Margins vs Trailing 10-Year Average, in Percentage Points (LHS) Unit Labor Costs vs. Trailing 10-Year Average (RHS) 3.0% 10% 2.5% 9% 2.0% 8% 1.5% 7% 1.0% 6% 0.5% 5% 0.0% 4% -0.5% 3% -1.0% 2% -1.5% 1% 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Source: Guggenheim Investments, Haver Analytics. Data as of 9.30.2019. *Note: Profits with inventory valuation and capital consumption adjustments expressed as a percent of GDP. Four quarter moving average. For financial professional use only. Do not distribute to the public. 13 Businesses Are Responding by Cutting Job Openings Job Openings Have Ticked Down Job Openings Relative to Trailing 5-Year Peak (3m Avg) 0% -5% -10% -15% -20% -25% -30% -35% -40% -45% -50% -55% 1986 1990 1994 1998 2002 2006 2010 2014 2018 Source: Guggenheim Investments, Haver Analytics, BLS. Payroll data as of 11/30/2019; job openings data as of 10/31/2019. Shaded areas represent periods of recession. For financial professional use only. Do not distribute to the public. 14 5. The Fed’s Soft Landing Theory Will be Tested Two-Year Change in the U.S. Unemployment Rate, in Percentage Points 6% 5% 4% 3% 2% Median FOMC 1% Projection 0% -1% -2% -3% -4% 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 Source: Guggenheim Investments, Haver Analytics, Federal Reserve. Actual data as of 12.31.2019. FOMC projections as of 12.11.2019. For financial professional use only. Do not distribute to the public. 15 6. Consumer Confidence Will Hinge on the Health of the Labor Market Conference Board Consumer Confidence Index, Y/Y Change Consumer Confidence (Present Situation), Y/Y Change (LHS) Consumer Perception of Jobs Plentiful Minus Jobs Hard to Get, Y/Y (RHS) 70 35 60 30 50 25 40 20 30 15 20 10 10 5 0 0 -10 -5 -20 -10 -30 Confidence is -15 below last year’s -40 level despite a 28% -20 stock market rally -50 -25 -60 -30 -70 -35 -80 -40 -90 -45 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 Source: Guggenheim Investments, Haver Analytics, Conference Board. Data as of 12.31.2019. Shaded areas represent periods of recession. For financial professional use only. Do not distribute to the public. 16 Message Curve Yield Affirming of Future, Reveal Survey Dimmer Data Views Source: Guggenheim Investments, Bloomberg. Data as of 12/31/2019. Shaded areas represent periods of recession. of recession. periods represent areas Shaded as Data of 12/31/2019. Bloomberg. Investments, Guggenheim Source: 3m10y Treasury Yield Curve and Conference Board Consumer Expectations Minus Present Situation Present MinusExpectations Consumer Board Conference and Curve Yield Treasury 3m10y -3.0% -2.0% -1.0% 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 1/1/1980 11/1/1980 9/1/1981 7/1/1982 5/1/1983 3/1/1984 1/1/1985 11/1/1985 9/1/1986 (LHS) Curve Treasury 3m10y 7/1/1987 5/1/1988 3/1/1989 1/1/1990 11/1/1990 9/1/1991 7/1/1992 5/1/1993 3/1/1994 1/1/1995 11/1/1995 9/1/1996 7/1/1997 5/1/1998 3/1/1999 Consumer Expectations - Present Situation (RHS) 1/1/2000 11/1/2000 9/1/2001 7/1/2002 5/1/2003 3/1/2004 1/1/2005 11/1/2005 Consumer and Business Survey Data Confirm Late 9/1/2006 For financial professional use only.
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