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Market movements
Last week was particularly poor for equities, with the S&P 500 for example falling by over 2% and recording its worst weekly performance this calendar year. This decline was led by uncertainty over the European elections at the weekend and a very weak jobs number from the US on Friday.
The macro picture
It is fair to say that the economic climate has changed in recent weeks, with mixed data pointing to a weaker macroeconomic backdrop than earlier in the year. Looking at the Citigroup Economic Surprise Index, which measures how actual economic releases fare relative to expectations, it has been trending downward quite sharply now for several weeks and is beginning to approach the lows that we saw in the middle of 2011 and 2010.
Investors are therefore more pessimistic than they were earlier in the year and indeed actual numbers have been mixed at best. Economic data from Europe in particular has shown weakness, although we should recall that Europe accounts for only 3-4% of global growth. Numbers have not slowed noticeably in emerging markets in the last six weeks and while there are some signs of slowing gradually in the US, we are looking at a diminution in growth rates in decimal points rather than a big downturn. Taken as a whole, 80% of the world is doing pretty well in terms of overall growth rates for 2012 and of the 20% that isn't (particularly Europe), the problems are well documented.
While absolute growth rates for the year are not in an awful place, we do however know that economic momentum is slowing globally at the moment. For example, 75 of global PMIs have fallen over the last month compared to March.
It is, though, a different story for corporate earnings. Corporate profitability relative to expectations remains pretty strong. So far, 400 out of the 500 S&P 500 companies have reported Q1 earnings. 71% of those have surprised consensus expectations on earnings numbers and 68% on sales. Even in Europe, 57% of companies which have reported have beaten expectations on earnings data.
In addition to this relative strength there are a number of factors at play which are supportive of global growth. These include the global easing cycle, improving US housing dynamics and China's policy switch. The combination of these factors means we are unlikely to see anything like as dramatic a slowdown in economic activity as we saw towards the end of 2011. In turn this means that central banks, while remaining committed to supporting economic activity, are unlikely to introduce anything new and aggressive into the policy mix.
Therefore, it is worth highlighting that in the past three and a half years, most of the big upswings in equity markets and risk assets more broadly have been accomplished during periods where central banks have been actively expanding their balance sheets.
European politics
Francois Hollande's win in the French presidential election did not come as a great surprise, nor should the fact that the Greek election has so far failed to result in a governable coalition. On Monday following the election results, there was an initial sell-off in European equity markets, but all, with the exception of Greece, then rallied quite sharply. We have already heard most of the pro-growth rhetoric that Francois Hollande is going to parade. It now comes down to whether or not he can carry some of the other European leaders with him and whether there will be a genuine division of views about austerity measures. However, we are unlikely to have much visibility about this until the EU summit in mid-June. We believe it is pretty improbable that there will be enough in the tank for growth to pick up, but at the polls there seemed to be more hope and even the markets are beginning to wonder if there is a new way forward for the European economy. For now, we remain sceptical that growth will be accomplished.
Commodities
At the beginning of the year there was some concern about a rising oil price holding back economic activity. However, that seems to have stalled as oil prices have been flat or down over the last month. Looking at the energy cycle, the only thing which is rising is the natural gas price, although that is from a very over-solid level. The coal price is down and commodity prices in general are lower. As a result, any concerns about the impact on inflation and activity due to rising prices now seems more limited.
Emerging Europe
BlackRock's emerging markets equity team reports that emerging European stocks are now trading at extremely cheap levels. For the first time in four years their multi-asset team has a positive stance on the region, noting that both Turkey and Russia (the main tradable markets) are very cheap and currently discounting some quite unpleasant outcomes. These are outcomes which their colleagues in the emerging markets team believe are unlikely to come to fruition.
Outlook
Stepping back to make sense of these themes, we believe we are now in a period where equity markets are working their way slightly down, but not aggressively. This is in response to slowing economic conditions and a lack of immediate stimulus. Stocks have got to get a little cheaper (making the risk premia big enough) for buyers to really come in. We remain convinced that the world is not going to collapse in a heap, nor are expectations, but we do see some slowing in growth momentum over the next several months.
The problem children still lie in Europe; there is no doubt that the European sovereign debt and banking crisis is not over. This is a multi-year crisis and we are going to continue to see its poisonous impact on European growth, politics and the standard of living in the region, despite the rhetoric heard at elections this week.
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