Long-term sovereign bond yields declined significantly due to global economic slowdown concerns
Global equity markets declined sharply in the past week, due to (i) the prospect of weaker global economic growth ahead, because of the spread of the Covid-19 Delta variant and (ii) heightened tensions in the United States – China relations.
The S&P500 decreased by 1% wow, recording additional losses of -1.6% on Monday 19th, whilst the losses in the euro area were even greater, as the Eurostoxx50 lost -2.7% on Monday. Reflecting concerns about future growth prospects, long-end US Treasuries have rallied significantly, with 10-Year nominal yields declining by 26 bps since end-June to 1.19%, leading to a material unwind of the key reflation trades.
Indeed, Value has lagged Growth by 286 bps since end-June, whereas Small Caps have lagged Large Caps by 660 bps for the same period. US Energy and Financials stocks have underperformed the market by 1197 bps and 351 bps, respectively, as the decline in oil prices and the flattening of the curve, poses downside risks to corporate profitability.
Having said that, the US Q2:2021 earnings season has begun on a strong footing. Specifically, the mean positive EPS surprise per company (actual result versus consensus expectations), hovers at +23% vs a 5-year average of +8% with consensus now expecting EPS of $47.
Financials have led S&P500 EPS surprises, due to better top line growth, as well as due to large loan-loss reserve releases. Overall, 2021 and 2022 S&P500 EPS growth is expected at +39% ($191) and +11% ($212), respectively, from -14% in 2020. Equally importantly, 12-month forward earnings revisions ratios remain in positive territory.
From a valuation perspective, S&P500 trades at a 12-month forward P/E of 21.4x (94th percentile vs 20-year history). Note, however, that multiples have de-rated ytd, with the P/E ratio down by 5%. As a result, the 15% price appreciation (S&P500) ytd has been solely due to increasing expectations of corporate profitability, with the 12-month forward EPS up by +20% ytd to $203.
The European Central Bank (July 22nd) is expected to keep policy unchanged (interest rates, PEPP, APP). The forward guidance is likely to redefined to be aligned with the Bank’s new strategy. It should be noted that market pricing for ECB interest rates by end-2022 and end-2023 was broadly stable post the Strategy Review announcement, while 2024 pricing dropped 4 bps, in line with the “lower for longer” narrative.
Fed Chair Powell indicated that the FOMC still views the US economy as “still a ways off” from the standard of having made the progress in order to reduce asset purchases. He said that tapering will be discussed at the next meeting (28/7) and that the Fed will give the market ample warning before adjusting asset purchases.
Regarding inflation, he acknowledged that some inflation pressures are stronger and more persistent than he had anticipated. He used, however, the price action of lumber, which is now trading at 8-month lows ($536/thousand board feet) after rallying +543% from the pandemic lows, as an example of the, expected, transitory path of inflation.