After a positive reaction to Alcoa's results on Tuesday, equity markets had a bad end to the week, with the FTSE 100, S&P 500 and the Eurofirst 300 closing down over 2%. The Nikkei 225 index of Japanese stocks fell over 7%, leaving the index at a six month low. The Nasdaq index of leading technology companies, which has been the focus of much of the valuation concerns, fell 2.76%, in line with the S&P 500. The correction in the Nasdaq is now almost 10% from the high of earlier this year and down 3.5% from the start of the year. The Vix rose on Friday to close the week at 17. Recent equity market sell-offs have stabilised once the Vix has risen above 20. Investor sentiment continues to get more bearish, the AAII investor sentiment index I refer to from time to time, this week reported that now only 28% of those surveyed think the market will be higher in 6 months time. This number is well below the long-term average of 39%, and in contrast from the start of the year when it was at over 40%.
We pointed out on Friday the lack of volatility in asset prices this year probably did not bode well for banking results this quarter. On Friday, JP Morgan was the first of the global banks to report first quarter earnings; both revenues and earnings missed analyst estimates and the shares fell 4% on the news. The earnings season gets into full swing next week; the highlights will probably be Citi on Monday, Intel, J&J, Coca Cola on Tuesday, and Blackrock on Thursday.
As we repeatedly point out after the rise we have seen in the past year in equity markets, taking valuations far closer to long term averages, continued impetus for the rally in equities will need to come from corporate earnings growth. As always what will carry a lot of weight amongst investors is the outlook statements that accompany the results. If there is a sense that corporates are feeling more positive about the year ahead, this should give investors renewed confidence. Mergers and acquisitions have picked up in the first quarter of 2014, European acquirers are at the highest level since Q1 2008. This increase in corporate activity could be a sign that CEOs are becoming more positive on the outlook for the global economy.
Despite the recent correction, the S&P 500 remains close to its all time high, and most developed markets have so far held on to a large proportion of last year's gains. One could argue that equities have been remarkably resilient in the face of the Chinese attempting to take air out of its economy, uncertainties in the Ukrainian region, the Federal Reserve's tapering of its asset purchases and a constant supply of new issues.
Equity markets do not rise in a straight line and this correction may have further to go particularly if the earnings season is no better than in line with expectations. On the plus side, for the first time in several years all the developed economies of the world should show real economic growth this year, interest rates will remain low and there is the possibility at some stage additional stimulation could come from China, Japan or the ECB. This, of course, is no guarantee that equity prices will remain resilient but it does at least give them a favourable backdrop to work with.