The performance of equity markets made headlines across the globe on Monday, the Dow Jones losing over 1000 points in early trading, before it staged a recovery. The Ftse 100 had fallen on 10 straight days. The vix rose to 40 after an unprecedented rise in terms of speed, fear had taken hold well and truly. As equities rallied at the start of Tuesday, the next question will be is this the end of the shakeout or a relief rally after sharp falls?
The catalyst for the change in heart for equities on Monday appeared to be a letter from the Apple chief executive to CNBC’s mad money presenter Jim Cramer, informing him that sales in China were robust in the past couple of months. Shares in Apple rallied immediately by almost 10% from the lows, recovering something like $80bn in market capitalization.
Corrections in equity prices are always harsh; the FTSE 100 at one stage on Monday had lost 4 years of gains in almost as many days. The blame was laid at the doorstep of China and the holiday season. The reality is that equity prices and valuations had got out of kilter, particularly in the US, and the Chinese correction provided the catalyst.
Looking at the facts post the correction, not much has changed in terms of economic growth expectations for this year and the next. They remain close to 3%. Inflation expectations and interest rate expectations have remained fairly stable. What caught our eye was the relative lack of movement in US treasury prices during the correction. US treasury prices did rise leading to a fall in yields, but not so dramatically as one could expect during the period of equity volatility. Ten-year treasury yields are currently 2.11%, almost where they started the year. That would suggest the bond market has not altered its assumptions for US economic growth in the past weeks. The Citi US economic surprise index has ticked up in the past months, suggesting economic activity is improving in that region.
Post the correction US equities trade on approximately 15x earnings, using factset estimate of $127 a share eps forecast, much closer to the long-term average of 14x. European equities now trade on 13.5x earnings with a yield above 3.5%, according to Merrill Lynch, again much more in line with historic averages. The earnings season in Europe was robust; eurozone earnings are forecast to grow around 13% this year. The volatility may not have ended and many uncertainties remain, but at least it would appear some of the froth has been taken out.