Credit analysts dont get the stock market.
Yesterday (Monday November 28), the S&P 500 closed 2.92% higher, the Eurostoxx 50 was up an impressive 5.23%, and the FTSE 100 index rose 2.87%. Meanwhile the Nikkei 225 was up 2.30% on Tuesday morning.
These stock market rises came even as the OECD issued a bleak outlook for the euro area, projecting two quarters of GDP decline. Its forecast for 0.2% growth in 2012 still looks too optimistic to many bank economists who were busily revising down their forecasts for the European economy in 2012 even further. Deutsche Bank, for example, cut its 2012 euro area GDP forecast from +0.4% to -0.5%.
Moodys Investor service warned yesterday that the continued rapid escalation of the euro area sovereign and banking credit crisis is threatening the credit standing of all European sovereigns.
Even the ratings agencys positive case for Europe, which envisages a resolution of the crisis before serial and disorderly sovereign defaults, sounds painful.
And the likelihood of a far worse outcome is increasing by the day.
That would likely lead to one or more countries leaving the euro. So, a strange day for a stock market rally, then?
But maybe the equity markets are not so disengaged from the awful reality unfolding in the government bond markets.
While equity markets did not fall in absolute price terms over the summer, even as government bond markets collapsed, they failed to rise on strong earnings, especially in the US but also in Europe, and on record margins.
|European PE multiple is driven by sovereign risk (Sov-X)|
|Source: UBS, Reuters|
Day-to-day equity market volatility no doubt reflects hopes and fears over whether Europe comes so close to disaster that politicians finally come up with a resolute response. The equity market is trying to price in a small-to-moderate risk of a catastrophic outcome and not managing that task very well.
Daily volatility may not exactly mimic the ups and downs of government bonds but the correlation is closer than first appears.
Nick Nelson, equity strategist at UBS points to the rise in yields of the SovX index since October 2009, with the fall in the 12-month forward price earnings ratio on the DJ Stoxx 600.
When equity P/E ratios fell from around 15 to 10 as yields on the Western Europe SovX rose from around 80bp to over 300bp, even as margins and earnings did so well, that was equity markets panicking. Absolute equity prices held steady and barely moved...but that didnt tell the story.
- Euromoney Skew Blog