Week End Blog – ECB policy, global trade, and rich valuations

This week was dominated by the ECB meeting on Thursday. While the ECB, again, refrained from changing its monetary policy, Draghi did seem to hint at some action in June, during the press conference. This resulted in a reversal of the movement in the EUR/USD exchange rate and pushed the 10-year yields on Italian and Spanish government bonds clearly below the 3%-threshold.

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The market seems to anticipate at least some ECB action. A model based on a simple linear regression, with the ZEW expectations index, the core CPI and the short term interest rate as explanatory values, estimates a current German 10-year bond yield of almost 3%, substantially higher than the actual yield of 1.46%.

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Not all that likely at this moment, but any QE action by the ECB would almost certainly be good news for European equities. If there is any graph that reflects the last five years on the stock markets, it is the one that shows the relationship between the amount of QE and return on equities.

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As the previous graph shows, Japan is the only dissonant in the relationship between QE and return. Japan has the biggest QE program, but no longer tops the ranking of equity market performance. While the value of the yen has somewhat stabilized, the Nikkei has strongly underperformed global equities. The economic momentum has completely deteriorated in response to the sales taxes increase. However the earnings development remains solid.

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World trade has yet to ignite. Latest data from the two export powerhouses, China and Germany, reveal an ongoing slowing of trade. Export growth of the two countries shows strong resemblance and is coming down.

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Let’s move to the US. After a strong ISM manufacturing number last week, the Markit PMI and ISM non-manufacturing also came in stronger than expected. I repeat, the US are in recovery mode, embrace it.

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Meanwhile, US equities are getting a bit expensive. The often mentioned Shiller PE is a good example of this, but the increase in valuation is reflected by other measures as well. Below is the price-to-sales ratio which has reached multiyear highs. Now, I realize that earning margins are also very high, leading to big profits out of the company sales, but it is a measure to keep in mind.

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