Image alt tag

Error!

There was a problem contacting the server. Please try after sometime.

Sorry, we are unable to process your request.

Error!

We're sorry, but the Insights and Intelligence Tool is temporarily unavailable

If this problem persists, or if you need immediate assistance, please contact Customer Service at 1-888-522-2388.

Error!

We're sorry, but the Literature Center checkout function is temporarily unavailable.

If this problem persists, or if you need immediate assistance, please contact Customer Service at 1-888-522-2388.

Tracked Funds

You have 0 funds on your mutual fund watch list.

Begin by selecting funds to create a personalized watch list.

(as of 12/05/2015)

Pending Orders

You have 0 items in your cart.

Subscribe and order forms, fact sheets, presentations, and other documents that can help advisers grow their business.

Reset Your Password

Financial Professionals*

Your password must be a minimum of characters.

Confirmation Message

Your LordAbbett.com password was successully updated. This page will be refreshed after 3 seconds.

OK

 

Market View

Here, we attempt to sort out the current investment environment—and whether select asset classes still present attractive opportunities. 

 

In Brief

  • Trade-related fears and an inverted U.S. Treasury yield curve have caused investors to become overly pessimistic, in our view.
  • By examining measures such as forward P/E ratios and the equity risk premium, we think that stocks still offer upside potential.
  • Meanwhile, our view of U.S. high yield spreads and market fundamentals suggests that the asset class retains its appeal for investors.
  • While risk asset valuations are no longer as attractive as they were at the beginning of 2019, we believe investors should strongly consider stocks and credit in the current economic environment.

 

Today’s market environment features a number of cross-currents that may have investors puzzled—or alarmed—about valuations of select asset classes. But are these concerns merited? Here, we address some key questions that may be top of mind right now.

1.  If the market is doing well, why are some investors pessimistic?
On the surface, the fact that major U.S. equity indexes are near record levels (the S&P 500® Index crossed the 3,000 mark for the first time on July 10) would seem to indicate positive tidings for the U.S. and global economies, central bank policy, etc.  But investors have had to contend with a barrage of dramatic headlines in the past few months, mainly trade tensions with China, an inverted U.S. yield curve, and prospects for monetary easing by the U.S. Federal Reserve (Fed). The first two topics have fueled concerns that the U.S. economy could be close to tipping into recession, while the third has sparked a debate about how accommodative the Fed might become at upcoming policy meetings. Add to that a pattern of sharp downward revisions to global earnings expectations, based on Bloomberg data, and investors appear to have become pessimistic about the future, as evidenced by expectations for stock prices 12 months hence:

 

Chart 1. Glum and Glummer: Some Investors Expect Lower Stock Prices a Year from Now
Expectations for year-ahead equity prices from the Conference Board’s June 2019 consumer confidence survey, January 1, 2017–June 30, 2019

Source: Bloomberg. Data as of June 30, 2019.
The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results. Investors may experience different results.
Past performance is not a reliable indicator or guarantee of future results.

2.  What are U.S. and global P/E ratios telling us?
Leaving aside the matter of whether investor sentiment measures are actually good predictors of market performance (they aren’t), let’s take a closer look at current equity valuations. Chart 2 shows forward price-to-earnings (P/E) ratios for U.S. and global stocks. We think it’s more important to look at forward P/E ratios, which capture expectations of future earnings, than it is to get the “rear-view mirror” perspective of current P/Es (that is, comparisons based on the trailing 12 months).

 

Chart 2. Equity Valuations Remain Near Long-Term Averages
Data for the period June 30, 1994–June 30, 2019

 

Source: Bloomberg. Data as of June 30, 2019.
The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results. Investors may experience different results.
Past performance is not a reliable indicator or guarantee of future results.

 

The left panel shows that U.S. equity valuations, even after a recent rally, are a little above the long-term average, and well below their peak of 18.5 times reached in early 2018; based on the display on the right, global forward P/E ratios are hovering near their average. In meetings with investors, we are often asked why, with all of those negative potential factors out there, equity valuations remain near average levels, and haven’t headed lower.

The answer, in our view, is twofold. For one thing, not all the economic news is bad. Some of it is quite good. Even as manufacturing and business sentiment data have softened in the United States, the labor market remains strong, consumer spending remains robust, and the housing sector continues to improve. And while the recent inversion of the yield curve may have presented a recessionary signal to some market observers, there are a number of other indicators, including a measure of U.S. financial conditions1 and a widely followed basket of economic data releases,2 that point to a continuation of the record-long U.S. economic expansion.  We believe much of the recessionary focus distracts from the key point regarding the yield curve—that this low rate environment makes valuations in other asset classes look even more compelling.   

3.  What are negative real yields, and why are they bad?
The second part of the answer has to do with the Fed. We're hearing a lot about expected rate cuts. While looser policy typically has a stimulative effect on economic activity, it also has a very real impact on investment yields. In the past, we’ve discussed the term premium, the incremental compensation for taking term risk received by investors.  As we can see in Chart 3, that compensation has been non-existent to negative for years, as ultra-low interest rates and quantitative easing policies from the Fed have taken their toll. Combine a negative term premium with negative real interest rates—basically, Treasury yields minus the rate of inflation—and the picture becomes quite grim for investors seeking attractive returns from “risk-free” investments.

 

Chart 3. Low Term Premium, Negative Real Yields Make for an Unappetizing Combo
Estimated term premium on the 10-year U.S. Treasury note and the inflation adjusted yield on the 10-year U.S. Treasury note, January 1, 1984–June 30, 2019

Source: Federal Reserve Bank of New York and Bloomberg. Data as of 06/30/2019. Real 10-year yield represents the 10-year U.S. Treasury yield less the Consumer Price Index (year-over-year).
The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results. Investors may experience different results.
Past performance is not a reliable indicator or guarantee of future results.

 

This is a rather interesting—and quite uncommon—phenomenon. If investors are not getting compensated for term risk, and inflation-adjusted rates are actually negative, what are the practical implications for portfolios? U.S. Treasury bonds are much riskier than usual given low real yields and a negative term premium.

While we haven't spent a huge amount of historical time in a world of negative real yields, we do know that (a) they make things unpleasant for investors in ultra-safe government debt, given the higher levels of interest-rate and inflation risk, and (b) they spur investment in risk assets. Investors, quite rationally, seek to do other things with their money.

4.  What might low interest rates mean for equity returns?
While Treasury investors may not be happy with the current state of affairs, today’s ultra-low rates have made valuations in two other asset classes—equities and U.S. high yield—quite compelling, in our view.  In the case of equities, we think the tailwind of low rates is quite evident when considering the so-called equity risk premium, which is the excess return that equities provide over “risk free” U.S. Treasuries. Based on Chart 4, that premium is well above the long-term average, and not too far from multi-decade highs.

 

Chart 4. U.S. Equity Risk Premium Remains High Even amid Stock Rally
Annual data for 1964-2019 (six months through June 30)

Source: Damodaran Online and Lord Abbett. Data as of 06/30/2019. Equity risk premium (ERP) is the excess return that an individual stock or the overall stock market provides over a risk-free rate.
The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results. Investors may experience different results. Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future.
Past performance is not a reliable indicator or guarantee of future results.

 

We are ultimately faced with reconciling two distinct views of equity valuations. The forward P/E measure we examined earlier suggests current valuations are fairly average. But when you take the incredibly low level of current interest rates into account, equities look about as cheap as they’ve been in a very, very long time, in our view.

5.  Where does high yield fit into all this?
We think there's another category of risk assets that may be worth a fresh look in the current low-rate environment: high yield, where spread levels tell a similar valuation story to equities.

 

Chart 5. U.S. High Yield Spreads Have Tightened, but Remain Above Historic Lows
Spread versus U.S. Treasuries, January 1, 1994–June 30, 2019

Source: ICE Data Indices. Data as of June 30, 2019. OAS=option-adjusted spread.
The information shown is for illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment.  Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future.
Past performance is not a reliable indicator or a guarantee of future results.

 

Chart 5 shows that spreads are a little tighter than average. However, they are still well above lows reached in earlier years. We think there are a number of factors that favor the asset class: low default rates, as measured by J.P. Morgan; companies’ ability to easily refinance speculative-grade debt in today’s low-rate environment; and the current rating composition of the benchmark high yield index (the ICE BofAML U.S. High Yield Constrained Index). We believe high yield may be overlooked by many equity-focused investors, but it can provide similar returns, along with the opportunity for portfolio diversification. Combined with what we consider attractive valuations for the asset class, we think high yield still presents a compelling opportunity.

6.  What are the key takeaways here?
We believe that investors may have become overly pessimistic about recent developments like U.S.-China trade frictions and the recent inversion of the three month/10-year U.S. Treasury curve. To be sure, at first glance, key measures of equities and high yield suggest that both asset classes are fairly valued. But given the current health of the U.S. economy, the prospect of a lengthy period of low interest rates accompanied by low inflation (enabled by an accommodative Fed), and solid market fundamentals, you could still make a very compelling case that equities and high yield present opportunities for solid returns in the future, in our opinion. Also, given the excessively negative tilt of analysts’ earnings forecasts, equity valuations may have additional room to reprice as those forecasts improve, in our view.

While risk asset valuations are no longer as attractive as they were at the beginning of 2019, we think both equities and U.S. high yield merit a closer look from investors.

 

1The Chicago Fed National Financial Conditions Index is a gauge of U.S. financial conditions compiled by the U.S. Federal Reserve Bank of Chicago. The index tracks measures of financial stress and tightness of credit markets.
2The U.S. Index of Leading Indicators is used to predict the direction of U.S. economic movements in future months. The monthly index, compiled by the Conference Board, is composed of 10 economic components whose changes tend to precede changes in the overall economy. 

 

MARKET VIEW PDF


  Market View

About The Author

RELATED FUND
The Lord Abbett Affiliated Fund Class A invests primarily in dividend-paying stocks of large U.S. companies. Access performance and portfolio information.
RELATED FUND
The Lord Abbett Growth Leaders Fund Class A seeks to deliver long-term growth of capital by investing primarily in stocks of U.S. companies. Learn more.
RELATED FUND
The Lord Abbett High Yield Fund has offered a track record of strong performance versus peers in up and down markets. Learn more.
image

Please confirm your literature shipping address

Please review the address information below and make any necessary changes.

All literature orders will be shipped to the address that you enter below. This information can be edited at any time.

Current Literature Shipping Address

* Required field