Global Weekly: Equities - Markets take a breather

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Over the past week, equity markets took a small step back after a strong start to the year. Most indices retreated by several percentage points. Apparently, investors had become somewhat uneasy after the long upward streak that we have seen in recent months.

Although macro fundamentals continue to be strong, rising yields – after ECB comments on potential tapering – and a technical correction in the oil price might have triggered a market pause.

From a sector perspective, health care was in the limelight this week. Amazon, JPMorgan and Berkshire Hathaway announced a partnership to enter the health care market. Although this potential sector disruption will take years before materialising, the announcement itself led to a negative sentiment in the health care sector this week. The health care sector was also in focus due to merger & acquisition activity, with Sanofi paying a hefty take-over price for Belgian biotech company Ablynx. Furthermore, as the earnings season continued on full steam, a string of pharma companies presented fourth-quarter results this week. On balance, these numbers did not offer a very convincing picture as several health care players, including Eli Lilly, Novo Nordisk, Roche and Sanofi, did not entirely meet expectations.

Looking at the technology sector, the earnings season on balance offered a very decent picture, with Intel, Microsoft, Amazon and Facebook posting strong numbers and encouraging outlooks. These results could have a supportive effect on equity markets in the near term. Meanwhile, in the run-up to the presentation of quarterly results, Apple’s share price was weak on rumours of further iPhone X production target cuts. On Thursday, however, Apple reported numbers that seemed to provide some relief to investors.

Based on reported company results so far, this earnings season could be one of the strongest on record with up to 80% of earnings reports coming in ahead of expectations. As in multiple cases the share price reaction was not always positive, earnings surprises seemed to be partly baked in the cake. At the same time, we continue to believe that underlying fundamentals for equity markets remain supportive.

Bonds – Sustained yield increase on the cards?

The strong global economy, increasing risk tolerance and an end to the ECB’s asset purchase programme later this year are set to put further upward pressure on bond yields. Last week’s ECB meeting added fuel to the bond sell-off. German 10-year Bund yields are currently testing the 0.70% level and 5-year yields even bounced back to positive territory for the first time since 2015.

On the back of a stronger euro, the outlook for euro inflation is set to stay subdued – despite decent growth in inflation expectations which can be related to the increase in oil prices. We do not expect euro core inflation to pick up significantly this year. However, if economic data remains strong, the market may become more nervous about an earlier-than-expected inflation revival. Solid economic data is currently benefiting peripheral spreads, particularly in Spain. Italy remains the big risk factor. We believe Italian spreads could tighten as well, but not just as result of rising Bund yields. At the moment, yields on 10-year Italian sovereign bonds still hover around 2%.

The Federal Reserve is expected to reduce its balance sheet at a very gradual pace, with limited direct impact on US Treasuries. But as the US Treasury Department will increase government bond issuance by USD 42 billion per quarter to address the growing budget deficit, net issuance will increase more sharply. This should continue to depress the mood in the market for US Treasuries. All in all, we currently consider bonds not to be an attractive asset class and remain vigilant. That said, the difference between yields on 30-year (2.95%) and 10-year Treasuries (2.73%) is quite narrow (only 22 basis points), indicating that the market is currently not too worried about higher inflation and rising interest rates.