Decoding Financial Markets in 10 Charts

Posted on 10. Apr, 2018 by Jean Jacques Ohana in Weekly Focus | 0 comments

By Jean-Jacques Ohana, CFA and Dr. Christian Witt, 10th April 2018

In a context of monetary tightening, global market liquidity has considerably deteriorated. This is potentially troublesome after investor complacency has driven worldwide equities to elevated valuations. We accordingly adopt a defensive positioning.

1. Global market liquidity has considerably tightened after 18 months of abundancy.

Risk Aversion Indicator (source: Riskelia)

For a given asset class, the risk aversion indicator rates the reward market participants require for risk-taking. The scores are expressed in numbers of standard deviations to a set of moving averages (from 3 months to 2 years). They are averaged into a Global Risk Indicator characterizing the liquidity regime of financial markets.

2. Risky assets have started the year 2018 on an extreme level of complacency.

250 days rolling Sharpe Ratio of S&P 500 (since 1999)

3. Equity performance has been concentrated in the growth style over the last years.

Overall stock market performance rests upon a small number of growth stocks. Not only have growth stocks outperformed value stocks, but within the growth universe returns are dominated by a restraint group of 7 tech companies, the so called FANGMAN (Facebook, Amazon, Netflix, Google, Microsoft, Apple, Nvidia). However, judging by the dismal performance of the FANG+ index (-7%) in March 2018, the cycle of outperformance of Growth stocks vs. Value stocks which goes back to 2006 is presently called into question.

Performance of Russel 1000 Growth, Russel 1000 Value and NYSE FANG+ since 2015 (source: Bloomberg)

4. Equity valuation multiples have risen over the last 10 years.

The Price/Earnings Ratio of US and EU stocks (price divided by trailing 12-months earnings estimated by analysts, source: Bloomberg)

5. In Europe, earnings growth was absent over the last 10 years.

In Europe, equities are even more vulnerable as earnings growth has been null over the last 10 years. The absence of earnings growth is characteristic of a deflationary environment.

Compared growth of prices and earnings of European equities over the last 10 years (source: Bloomberg)

6. The flattening of the US yield curve: inexorable march towards the end of the cycle.

The monetary tightening of the Federal Reserve is not late from investors’ point of view. Long-term US rates are about to peak well before the Federal Reserve stops rising rates.

Differential between 10 years and 2 years yields on the US Curve (in %, source: Bloomberg)

7. Where has the feared inflation gone?

In Europe, low inflation is rather the most imminent threat just as the ECB is about to stop its program of asset purchases towards the end of year.

In the US, the supposedly symmetric inflation objective of 2% aimed for by the Federal Reserve has not been reached since 2012. Meanwhile, the US business cycle has entered the late stage of the cycle.

Annual Core Inflation Rates (excluding Energy and Food) in the US and in Europe (source: Bloomberg)

8. Economic cycles in the US and in Europe increasingly diverge.

Lower structural growth and inflation in the euro zone compared to the US explains why the German Bund noticeably over performed the US T Notes over the last two years.

Indices of economic surprises for the US and Eurozone (source: Citigroup)

9. The EUR/USD has decoupled from the yield spread.

2-year yield spread between US and Germany vs. EUR/USD FX Spot rate (source: Bloomberg)

10. Worries about the double US deficit (budget and external) have resurfaced and weigh on the dollar in the long run.

Current account and budgetary balance in the US and the euro zone (as % of GDP, source: Bloomberg)

Published on Riskelia’s Blog

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