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A Blue World Good For Risk Assets

Published 02/23/2015, 01:50 AM
Updated 05/14/2017, 06:45 AM

It is clear by now that we are trading in what we call the blue phase of the business cycle. In financial market terms, blue is an upbeat state. It is the phase where global growth is recovering while the output gap is negative leading to low cost pressure and very accommodative monetary policy. In this phase, we have historically seen very strong returns in stock markets. This is also the case this time. Being up 10.5% this year, Euro Stoxx 50 has been the star performer supported by accelerating growth and significant QE from the ECB. Our expectation of trading in the blue world has been the main reason we have been positive on risk assets for a while.

So how long will the good times roll? Our models suggest we will continue to be in the blue world for at least the next couple of months. At the same time, there are some tentative signs of moderation when we go into summer. Our medium-term lead models for the OECD’s leading indicator, which predict the leading indicator with a three to six month lead, are starting to lose momentum. So, maybe sell in May and stay away will prove right again? However, for the coming months they point to a continued positive environment for risk assets. We also look for more upward revisions of euro area growth for this year (we have an above-consensus estimate of 1.5% for 2015, consensus 1.2%).

The main risk in the short term is uncertainty about Greece and that euro stock markets are moving into stretched territory on short-term momentum and thus risk-reward is not as good as it has been. However, the tailwind from stronger data and ECB easing is expected to dominate for the coming quarter and we still see more upside.

The surprise index in the US, which has fallen substantially, may also be close to a bottom as bad weather may have played a role in weak retail sales and fundamentals are still solid for the short-term picture in the US. We see signs of stabilisation in regional business surveys from Philadelphia and New York (Empire index) suggesting that the downward move in demand towards the end of 2014 will come to an end soon.

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