4 Factors Underpinning Risk Markets‏

Risk markets had a very strong run over the past week. The MSCI World stock index is up 3% and spread compression continued in both euro government markets and corporate credit. We generally see four factors underpinning risk appetite.

1. Tail risk lower again. Following the deal on the US debt ceiling there are few risk factors on the radar screen in the short term. The ECB statement on the Asset Quality Review turned out to be a non-event event, as it revealed few surprises (press release). The assessment of large banks will start in November and will take 12 months so it seems unlikely we will get any answers in the near term. In the medium term China seems to be the biggest tail risk but it is not a big theme in the market.
2. Fed tapering postponed further. This week’s weak payrolls pushed Fed tapering further into the future – most likely at least to March 2014 (see Flash Comment US, 22 October). That is six months later than what we thought a little over a month ago prior to the September FOMC meeting. As a result the markets can keep drinking from the punch bowl for longer. ECB also still has an easing bias despite the recovery.
3. Global recovery still unfolding. The US hit another bump in the road but there is still strong faith that the economy will speed up again next year as the strong fiscal headwind and the ‘bond yield shock’ fade. We agree with this view. At the same time, China and Europe are making sure that global growth is still moving higher in the second half of 2013.
4. Wage growth and rates low for long in developed markets. Finally the developed markets are recovering with substantial slack in the economy. Unemployment is high and wage pressures will be subdued for a long time. This is a) underpinning earnings growth when sales pick up and b) keeping inflation rates low for the foreseeable future, making sure monetary policy can stay accommodative for a very long time. In the short term some risk markets look a bit overbought judging from very high price momentum indicators. This sometimes causes a pause or correction in the market. Valuation is also getting somewhat stretched in OECD markets. However, the sweet spot for risk assets, in which higher global growth is coupled with continued loose monetary policy, is likely to be with us for some time. This should drive risk assets higher on a six-month horizon.