As highlighted in last week’s Strategy: A blue world is good for risk assets, Friday 20 February, the current phase of the business cycle with global growth acceleration and accommodative monetary policy is the best world for risk assets. This was confirmed in the past week with new highs for most major stock indices and new lows for credit and peripheral bond spreads. In addition to being in the blue phase, risk assets have seen a boost from a decline in tail risks in the past weeks:
1. Grexit: Greece and the EU reached a deal last Friday and reduced the probability of a Greek exit from the euro. On Tuesday the new Greek government sent a list of reforms to the euro group which so far has been endorsed (on condition that they are actually implemented). Barring any new set-backs this will pave the way for Greece receiving another loan payment from the EU in May and bridge financing until then.
2. Oil collapse: While the decline in oil prices provides a boost to global consumers it is also a tail risk as it may trigger financial turbulence in Russia and the US high-yield markets (where energy is around 20% of the market). However, over the past few weeks the oil price has found a bottom: oil prices halted their decline at USD45 per barrel (Brent) in mid-January and have increased to around USD60 during February. A sharp decline in the US oil rig count to the lowest level since 2011 and a big reduction in investment plans from the major oil companies have contributed to the stabilisation. Saudi oil minister Naimi also stated this week that ‘we want to see calm markets’ and added that ‘global oil demand is growing’. It thus seems that the Saudis are trying to talk some stability into the market as they are also aware of the risk of the negative effects on oil demand if the collapse in prices pushes Russia and US high-yield over the edge.
On the recovery front we have also had further encouraging news. Following a steep decline in the US surprise index we see the first tentative signs of stabilisation. Durable goods orders for January surprised slightly to the upside, pointing to stabilisation after some very weak months on the capex side. The flash US Markit PMI also showed the first increase in six months in February, which suggests that ISM could also bottom soon. We look for a small further decline in the ISM next week but overall we believe the worse is behind us. The main disappointment going forward could be in consumer confidence, as it seems to have had a major boost from the decline in gasoline prices. These have started to rise a bit, though, and thus it may take the top off the enthusiasm among consumers.
In the euro area, where we continue to look for an upside surprise to growth this year, the money and credit data were very encouraging. Real M1 growth now points towards GDP growth of 0.7% Y/Y. The German ifo expectations index also rose further to 102.5 in February, which points to above-trend growth (the long-term average of ifo expectations is 100.2). There was even good news out of France as household consumption for February showed the strongest growth since early 2012, when volatility is smoothed out. This again is a sign that the lower oil price is boosting growth in the euro area – even in the weakest link of the chain.
To wrap up the global economy we had positive figures out of China as flash PMI manufacturing surprised to the upside, moving up to 50.1 (consensus 49.5) from 49.7. It adds to tentative signs that Chinese growth has bottomed. The correlation of Chinese PMI with Emerging Markets stocks has been very high over the past years and it thus points to more support for EM assets (see chart).
To conclude, we are in a quite favourable environment for risk assets at the moment and we remain positive. The main negative in the short term is that momentum in many euro risk markets is running very high and has moved into stretched territory on some of our short-term technical indicators. It can sometimes stay ‘overbought’ for a while but tends to become more vulnerable to events that trigger profit taking in the short term.
1. Grexit: Greece and the EU reached a deal last Friday and reduced the probability of a Greek exit from the euro. On Tuesday the new Greek government sent a list of reforms to the euro group which so far has been endorsed (on condition that they are actually implemented). Barring any new set-backs this will pave the way for Greece receiving another loan payment from the EU in May and bridge financing until then.
2. Oil collapse: While the decline in oil prices provides a boost to global consumers it is also a tail risk as it may trigger financial turbulence in Russia and the US high-yield markets (where energy is around 20% of the market). However, over the past few weeks the oil price has found a bottom: oil prices halted their decline at USD45 per barrel (Brent) in mid-January and have increased to around USD60 during February. A sharp decline in the US oil rig count to the lowest level since 2011 and a big reduction in investment plans from the major oil companies have contributed to the stabilisation. Saudi oil minister Naimi also stated this week that ‘we want to see calm markets’ and added that ‘global oil demand is growing’. It thus seems that the Saudis are trying to talk some stability into the market as they are also aware of the risk of the negative effects on oil demand if the collapse in prices pushes Russia and US high-yield over the edge.
On the recovery front we have also had further encouraging news. Following a steep decline in the US surprise index we see the first tentative signs of stabilisation. Durable goods orders for January surprised slightly to the upside, pointing to stabilisation after some very weak months on the capex side. The flash US Markit PMI also showed the first increase in six months in February, which suggests that ISM could also bottom soon. We look for a small further decline in the ISM next week but overall we believe the worse is behind us. The main disappointment going forward could be in consumer confidence, as it seems to have had a major boost from the decline in gasoline prices. These have started to rise a bit, though, and thus it may take the top off the enthusiasm among consumers.
In the euro area, where we continue to look for an upside surprise to growth this year, the money and credit data were very encouraging. Real M1 growth now points towards GDP growth of 0.7% Y/Y. The German ifo expectations index also rose further to 102.5 in February, which points to above-trend growth (the long-term average of ifo expectations is 100.2). There was even good news out of France as household consumption for February showed the strongest growth since early 2012, when volatility is smoothed out. This again is a sign that the lower oil price is boosting growth in the euro area – even in the weakest link of the chain.
To wrap up the global economy we had positive figures out of China as flash PMI manufacturing surprised to the upside, moving up to 50.1 (consensus 49.5) from 49.7. It adds to tentative signs that Chinese growth has bottomed. The correlation of Chinese PMI with Emerging Markets stocks has been very high over the past years and it thus points to more support for EM assets (see chart).
To conclude, we are in a quite favourable environment for risk assets at the moment and we remain positive. The main negative in the short term is that momentum in many euro risk markets is running very high and has moved into stretched territory on some of our short-term technical indicators. It can sometimes stay ‘overbought’ for a while but tends to become more vulnerable to events that trigger profit taking in the short term.
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