Equity markets appear happy to go quietly into the month end, for the time being the events that caused the volatility earlier in the year seem to have becalmed themselves. Greece will return to the back pages as we wait for developments in four months time. The troubles in Russia continue to rumble along, but as we pointed out earlier this week, asset prices in the region have stabilised. Following the announcement of QE for Europe in late January, there does appear to be some signs of a modest pickup in economic activity for the region. Post the Chinese New Year celebrations even that region surprised on the up side as HSBC's latest manufacturing PMI estimate beat expectations on Thursday. Sentiment towards the region has improved, as the Bank of China remains willing to introduce further measures to stimulate the economy should the data start to weaken further. The oil price stabilised in the month of February, Brent oil is now up 20% from its lows, and finally, no shocks from central banks with regard to a change in rate policy.
The earnings season is nearly at an end without too many nasty surprises, despite this earnings revisions ratios are showing no real signs of turning higher. According to the latest Merrill Lynch survey the global earnings revision ratio stands at 0.67, meaning for approximately every 7 upgrades to earnings there are 10 downgrades. On the positive side this does mean there may be room for earnings upgrades later in the year if the global economy continues to show signs of recovery. According to the survey equity markets tend to rise around 5% in the following year when the ratio reaches this point.
Bond investors have taken the pain as yields have risen, particularly in the month of February. This is probably partly as response to generally slightly better economic data, and partly one suspects, as sentiment seemed to be getting overly bearish on the inflation outlook on the back of the falling oil price. Investor’s associate equity markets with sharp falls, and as we have been in such a long bond bull phase they forget it can happen in bonds as well!
Rising yields has meant cyclical stocks have outperformed defensive ones, taking many investors by surprise. The conundrum with equity prices looking stretched on P/E basis is that some of the valuation support comes from the enhanced yields equities offer. As bond yields rise this becomes less attractive, but conversely it can indicate an improving macro outlook which should be positive for stocks.
As we said the other day this equity market grind higher has been punctuated by bouts of volatility, one can only believe that pattern will continue into the months ahead.