Market Commentary
The everything-rally was back on, following the January bounce. Equities, credits, commodities increased while flight-to-safety currencies, the Japanese Yen and Swiss Franc slightly came off. VIX inched substantially lower. Stark contrast to the worst December performance in equities since 1931. For further context, this recent rally reflects the best start to the year since 1991 for U.S. equities and the best gain since 2001 for corporate high yield bonds representing simply a V-shaped recovery.
Graph 1: Market Liquidity
A stark contrast also to the peacefulness of 2017. What changed is that US Treasury yields have not recovered from the drop of Q4 2018, remaining at 2.6% p.a. for the 10 years. The rebound in 2019, following a longer trend, seems to be based amongst others, on corporate share buybacks, which have been fuelled by central bank complacency. Graph 2 below shows that asset managers have adopted a neutral stance on equities during the rebound. Moreover, hedge fund managers seem to agree that liquidity in financial markets has deteriorated (see Graph 1). Only the complacent central bank policy appears to be keeping financial markets afloat; any change in stance could generate a substantial correction, aggravated by poorer liquidity and asset liability misalignment of passive investment products.
Credit markets continued their recovery in February, following the steep declines seen in the fourth quarter of 2018. In the US, high-yield bonds and loans performed roughly in line. In Europe however, bonds outperformed loans. Through February, loans in the US had recovered approximately three-quarters of the price decline experienced over the last two months of 2018.
All risk assets experienced a frenzy-buy fever that is only partially justified by the U-Turn of the Fed. Economic growth uncertainties were just temporarily forgotten by investors trying to lock in gains from the bounce. Global bonds do
Graph 2: Asset Allocation Decisions Equities
not share the same opinion.
The total notional amount of global negative yielding debt soared recently, rising above $10 trillion for the first time since September 2017. Paradoxically, the amount of negative-yielding debt has nearly doubled in just six months. Negative yields mean that investors will lose money just by holding bonds to maturity. Forget about defending purchasing power: real yields are actively digging their own graves with several consequences. The sudden decline of European rates increased the gap between dividend yields and Government bond yields providing an indirect support to the equity market (Graph 3).