For a while now – since 19 September to be precise – the markets have stopped worrying about what US growth might do to interest rates (threatening equity valuations) and began to worry about growth itself.
News of deflation in Europe had fed these fears and helped force bond yields everywhere (including RSA yields) lower. Yesterday morning a weak US retail number, announced before the market opened in New York, was more than enough to encourage a dramatic sell off of leading equities and an equally dramatic rush to the apparent safety of bonds. We show the intraday moves in the bond markets below.
By the end of the New York trading day much (but not all) of the action had been reversed. By the close equities had moved off their lows and bond prices off their highs. But not all equities had come under the same pressure. The small cap Russell 2000 Index, a distinct underperformer since March this year, held up much better than the big caps and ended the day well up, gaining 1% by the close.
The rand, which had held up pretty well through the trading day given its risky character in a presumably risk off world, also gyrated late last night when the local traders were out of the markets. The rand then recovered with the equity markets.
The strength in the rand and US small caps suggests that this was not one of your normal risk off days. A combination of better news about the US economy – the news flow will be watched intensely this week and next – combined with the much lower yields from the money market, can become a renewed case for equities.
Deflation will hold down interest rates and operating margins; while dividends in the US may well hold up. It will also take a world that is less nervous about the future to revive the bull market in equities. This is best revealed by intraday volatilities and the VIX (the S&P 500 volatility index), which yesterday peaked above 30. Central banks will continue their efforts to reflate their economies, even if the room for still lower interest rates seems limited. The case for quantitative easing in Europe (creating money as well as holding down interest rates) is becoming harder for even the German economy and its central bankers to resist.
Bull markets usually end when reflationary policies (designed to fight deflation and below potential growth) are followed by deflationary policies that are designed to fight the inflation that comes with above potential growth in spending. We seem further away from a strong pick up in global growth and globally coordinated deflationary policies. Such prospects would be reflected by a steepening in the term structure of interest rates. The flattening of the yield curves in the developed world, and in SA, reveals that any upward move in the interest rates will be postponed. Any threat of higher interest rates to global equity valuations seems further away.
Equity investors must hope that US and global growth still holds up well enough to sustain satisfactory earnings and dividend growth predictions – as yet these have still to be revised downwards