Over the past few days, markets have become more unsettled by a government shutdown and a looming debt-ceiling showdown. While this political brinksmanship is frustrating, we believe it is important to not lose sight of the long term. Throughout the years, the markets have grappled with and persevered through many seemingly insurmountable challenges. We believe that the likelihood the U.S. government will default on its debt is very low, though we are prepared for Congress to take things down to the wire.
The U.S. economic recovery seems poised to continue its respectable pace, assuming that the government shutdown ends in the near future. The euro zone has inched into recovery, and Japan has introduced a host of economic growth reforms. Economic data coming out of the emerging markets (EMs) has been more uneven, but EMs look positioned to contribute to future global expansion, due in large measure to a growing consumer class.
Taking a closer look at the U.S., corporate balance sheets are healthy and corporate cash levels are high. We have often pointed to the role of small businesses as the engine of job growth, and by extension, a sustainable recovery. There has been good news on this front, as small businesses have recently found it easier to secure loans. Although job growth remains sluggish overall, small business hiring has been robust, near twice the level of large businesses.
A resilient consumer has been instrumental in the recovery thus far. Consumer debt levels have nearly returned to the levels of the 1990s. The “wealth effect” has gained traction, supported by housing price increases, equity market gains and falling gas prices.
Looking a bit further out, many are concerned about what will happen when the Federal Reserve tapers its bond buying programs, which have kept rates low. We believe that less intervention will ultimately serve the economy and the markets well. There should be more incentives for banks to lend money to smaller businesses and prospective homeowners, and fewer pricing dislocations in the equity market.
However, tapering will likely usher in higher interest rates; and therefore, there are important implications for investors. In our view, investors would be well served to revisit their allocations to government bonds, due to their high level of interest rate sensitivity. When rates move, they can move quickly and suddenly. Our concern is that many bond investors have not prepared themselves for a sudden rate spike.
In contrast, stocks remain compelling. The U.S. stock market looks to be in a mid-cycle secular bull market, with more room to move. While a rise in rates could take a significant toll on government bonds, stocks have not faced headwinds when moderate interest rates (4 percent to 6 percent for 10-year Treasurys) have been accompanied by economic expansion. This is because the stocks’ growth characteristics have outpaced the impact of rising rates. We believe that growth-oriented stocks are especially attractive, on the basis of price and participation in long-term secular trends. Our team has identified opportunities among dividend growth stocks as well.
We are also observing favorable conditions in the convertible market. Convertible securities blend the opportunity for upside participation in the equity markets, with the potential downside resilience. Their equity characteristics also make them less sensitive to rising rates. We have used them for more than three decades to help our clients enhance the risk/reward characteristics of their portfolios in ways that stocks or bonds alone cannot.
John P. Calamos Sr. is chairman, chief executive officer and global co-chief investment officer of Naperville-based Calamos Investments, the firm he founded in 1977. He will be participating in the Naperville Area Chamber of Commerce’s Regional Economic Forecast on Oct. 24, 2013 at Hotel Arista. Learn more about the event at www.naperville.net.