What were the significant economic developments this week?
We saw continued support for eurozone growth in various outputs.
Latest surveys from the Institute for Economic Research, which interviews around 7,000 businesses in different sectors, highlighted that the confidence of German businesses is at an all-time high. This input highlights that the trust of business in the recovery of the eurozone is very strong. As Clemens Fuest, Ifo president put it, and the businesses are feeling “euphoric”.
To confirm this trend, we have seen strong purchasing manager index figures around the eurozone. The latest poll suggests that the economic activity continues to expand at a rapid pace. PMI remained at six-year high at 56.8. This is well above the crucial 50 figure, which marks an expansion in activity within the eurozone.
The output from the US housing, although from high levels, disappointed this week. Given the shortage of the houses on the market, which keeps the prices high, existing home sales declined 2.3% last month. New home sales, which mark 9.8% of the overall home sales, also disappointed, but the general growth trend continues given the tightening labour market and historically low mortgage rates.
How did the market perform this week?
We saw a positive risk rally with major indices hitting record levels again. We saw a rally in Brazilian stocks (SA:BVMF3), after dropping largely last week. Further, the rally in the tech stocks continued this week. Overall, the broader stock market advanced 2.00%. The VIX index, which measures the volatility of the stocks, dropped nearly 30% and traded back at levels around 9.99.
We have seen a small spread widening in the Emerging Market Bonds, due to the stress in the Brazilian political landscape, while global high yield spreads remained at similar levels. As we note below, given the drop in the oil price, airline stocks rallied, while oil stocks declined nearly 2%.
Oil got hammered after the OPEC leaders agreed to continue the cut for another 9 months, while the market was expecting deeper cuts.
On the CCY side, we saw the pound weakening across the board, after latest GDP numbers disappointed and Conservatives' poll slide.
Is the tech sector valuation getting to stretched?
When we look at the performance of the S&P 500 this year, we see a performance of nearly 8%. Looking at the Nasdaq index, we see a 15.5% performance YTD. With more than 45% allocation to the tech stocks, the allocation to the Tech sector is naturally higher in the Nasdaq index. The technology sector has posted a stellar 20% performance this year. Looking at the growth factor, which typically has the largest allocation to technical stocks, has posted a 12.5% growth YTD.
The crucial thing about this development is that the breath in the market has literally collapsed. With roughly 12% market cap, stocks such as Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Facebook (NASDAQ:FB), Alphabet (NASDAQ:GOOGL) and Microsoft (NASDAQ:MSFT) have posted nearly 28% of the returns of the broader S&P 500 market. Given latest hedge funds statistics, although one should take these with a pinch of salt, hedge fund managers are also piling into these stocks. Naturally, investors should ask themselves if the valuation of the S&P 500 Technology Index is getting to stretch.
The valuation for the Technology Index, 18 times forward earnings, still looks reasonable. Nevertheless, given the continued trade for momentum and global reach for growth, investors should be careful in the allocation of their portfolio to the tech sector and should also not forget to rebalance some of their positions after this rally.
Will the ECB stop its quantitative easing over the summer?
As we have explained lately and also on this note above, the global economy is doing better. Especially the recovery within the eurozone seems to be ongoing quite well and thus the ECB is once again under pressure to stop its asset purchases. We have not seen the necessary fiscal stimulus from the eurozone countries since the crises broke out in 2008 and since 2015 we have seen an aggressive central bank trying to prop up the economy (as one can see from the graph below). While the pressure on the ECB to stop its QE remains, we think a gradual normalisation would be better, than an immediate stop, as it would continue to help the improving the economy and also be beneficial for global financial stability.
Investors should bear in mind, that a gradual normalisation will strengthen the EUR, increase eurozone rates and continue to support European stocks. However, the risk of miscommunication or early break-up could lead to higher volatility in the market.
Will the FED start to shrink its balance sheet?
Minutes from the May meeting highlighted that most FED members are in favour of scaling back its Balance Sheet. However, the timing of this still remains open and will most likely be clear over the next months. Nevertheless, they have agreed to a proposal under which the Federal Open Market Committee would announce a set of gradually increasing caps on the amounts of securities that would be allowed to run off every month. Below is an explanation of the Fed's proposal:
Participants continued their discussion of issues related to potential changes to the Committee’s policy of reinvesting principal payments from securities held in the SOMA. The staff provided a briefing that summarised a possible operational approach to reducing the System’s securities holdings in a gradual and predictable manner. Under the proposed approach, the Committee would announce a set of gradually increasing caps, or limits, on the dollar amounts of Treasury and agency securities that would be allowed to run off each month, and only the amounts of securities repayments that exceeded the caps would be reinvested each month. As the caps increased, reinvestments would decline, and the monthly reductions in the Federal Reserve’s securities holdings would become larger. The caps would initially be set at low levels and then be raised every three months, over a set period of time, to their fully phased-in levels. The final values of the caps would then be maintained until the size of the balance sheet was normalised.
Investors will be pleased to see a rather slower unwinding of the balance sheet of the FED, which will be accompanied by higher growth in the economy and positive for the risk rally. However, the risk of miscommunication or early break-up could lead to higher volatility in the market.
Disclaimer: This document has been prepared by Lion Value Partners AG. The information contained in this document is based on sources which are considered reliable but there is no guarantee as to the correctness and completeness of the information. The information could be changed at any time, without any obligation to notify the recipient thereof. Backtested performance is hypothetical (it does not reflect trading in actual accounts) and is provided for informational purposes only to indicate historical performance had the index portfolios been available over the relevant time period. Past Performance is no Guarantee of Future Results. Unless otherwise noted, all figures are unaudited and not guaranteed. All acts on the basis of the information take place on the own liability and danger of the recipient. This document is for informational purposes only. The information does not release the recipient from his own assessment. © 2017 Lion Value Partners AG. All rights reserved.