The past week saw strong performance for many risk assets. Peripheral bond yields keep going lower: the Spanish and Italian 10-year yield set new records, falling further below 3% and in the credit space Itraxx Europe five-year CDS index reached the lowest level since 2010. Global stocks continue to underperform in the risk space going broadly sideways. The strong performance of risk assets is supported by the following factors.
1. Global growth reacceleration. As we have highlighted in recent weeks, there are many signs that global growth is recovering from the weak spot in Q1 as both the US and China have seen a lift going into Q2. This week, the Chinese recovery was confirmed by better export data for April (see Flash Comment China: export growth in April driven by Europe and US, 8 May 2014).
2. Dovish central banks. This week we also saw more confirmation of soft central banks. In the US, Fed chairman Janet Yellen’s struck a dovish tone as expected in her hearing before the Joint Economic Committee in the US Congress. In the euro area, the ECB finally gave a very clear signal that more easing is in store at the June meeting in the form of a rate cut and the introduction of negative deposit rates. There is no sign that the punch bowl from the Fed will be removed soon and while we do not expect QE from the ECB (see below) it will be a theme as long as it has an easing bias. We also expect the Bank of Japan to step even further on the gas later this year as both growth and inflation head lower.
3. Search for yield. The extremely low rate environment feeds a continuous search for yield. Assets are getting more expensive across the board but where do you put your money? Cash is giving close to zero in returns and central banks tell us that this will be the case for a long time.
4. Tail risk is low. Although there are still risk factors in the global economy, the tail risk still seems low compared with what we have seen for many years. Over the past week, the geopolitical risk in the Ukraine/Russia crisis also seemed to go down a bit as Vladimir Putin softened his rhetoric.
To summarise, this is an environment where risk assets are poised to become expensive and the risk of bubbles down the road is becoming high. It could end in tears one day, but for now, risk assets stay well supported. It may also explain why we have not seen any meaningful correction in stock markets despite a slowdown in the global business cycle and higher geopolitical risks – factors that historically have been a trigger for corrections. When that is said, we have seen underperformance of stocks so far this year relative to other assets. Looking ahead, though, based on the above positive factors and more M&A activity, we now believe stocks will outperform again and change our three-month view from neutral to positive.
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