In a week with limited news on the economic front, risk markets have been jittery going into the earnings season. The main theme in the stock market has been a move out of growth stocks such as Biotech and IT, leading to the biggest correction in the Nasdaq index since 2011. The index is now down 7% from the peak in early March. After gaining close to 40% y/y at the peak, the market has become increasingly nervous over stretched valuation and profit taking has set in going into the earnings season. Part of the move has been a rotation into emerging markets (EM) stocks, which from a long-term valuation point of view look attractive. In addition, rising optimism about a cyclical recovery in China has triggered a flow back into EM stocks. The more positive EM sentiment is also reflected in a strong recovery in base metals over the past month after the market took a beating in early March.
Apart from concern over Q1 earnings disappointments, declines in leading indicators have also given rise to a more cautious approach to developed market stocks. The global, as well as the US, leading indicator from OECD has declined over recent months adding to evidence that the current slowdown has more to it than just bad weather. Stock markets often struggle to perform when the leading indicator is in decline, as illustrated in the bottom left chart on next page. The shaded areas in the chart shows periods of decline in the global leading indicator from OECD.
Looking to the credit space, spreads in Europe have not done much since January. The longer-term downward trend seems intact, though and given the positive carry to government bonds, credit has still outperformed a bit.
While returns in the stock market and credit have been unimpressive so far this year, the strong performance in peripheral bond markets has continued and has shown resilience even in times of falling risk appetite. The strong demand for peripheral bonds was yet again highlighted this week when Greece came to the market with a bond issue for the first time in four years. Greece aimed to raise EUR2.5bn and orders exceeded EUR20bn with close to 90% going to long-term investors outside Greece.
The picture of stretched valuation in certain segments and declining leading indicators leaves us cautious on the stock market. At the same time, we remain constructive on credit and peripheral euro bonds where we look for the long-term downward trend in spreads to continue. These markets are supported by the search for yield, improving fundamentals and the rising probability of QE from the ECB.
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