Europe is leading a worldwide rout of equities. While a myriad of headlines have contributed to the gloom, negative investor sentiment began to surge in earnest on October 2nd, when European Central Bank President Mario Draghi stopped short of quantifying how many assets the ECB is prepared to buy to head off deflation. Draghi said the ECB will buy assets for at least two years for as much as 1 trillion euros ($1.3 trillion). Investors wanted more. That day, European stocks plunged the most in 15 months.
European stocks just completed a fourth consecutive down week, accelerating more recently with eight consecutive down days through Thursday October 16th, the longest losing streak since 2003. Greek 10-year yields were up 72 basis points to 8.58 percent on October 16th, after jumping 85 basis points the prior day. This move in Greek borrowing costs was the biggest increase since July 2012, when the country was on the brink of exiting the European Monetary Union.
Greece’s sovereign bond yield has increased sharply in October. The selloff in Greek bonds has pushed yields to a level that threatens to once again cut Greece off from financial markets. A relapse of the European Debt Crisis is a core equity market risk and a focus of investor sentiment. The European Commission is currently engaged in a two-week probe of euro-area governments’ draft budgets and 2015 spending plans. While we anticipate a pragmatic policy response (eventually) from the ECB and European Commission, we don’t expect investor sentiment and global risk assets to bottom until Greek financial market indicators (see below) stabilize. Importantly, investors are familiar with these risks as they have heard this story before. The potential for a Greek exit from the European Union is a risk that must be respected. Euro leaders may be doing too-little too-late. However, guidance from central bank officials and the recent history of periodic growth scares followed by successive “rounds of QE” and European “bailouts” suggests that the central bank put on risk assets remains in place. Any price dislocation from fundamentals during this onset of uncertainty could be an opportunity to re-allocate to discounted equities. Dropping Greek sovereign yields and CDS spreads should act as an indication that investor focus shifting from Euro-Area systematic risk back towards market fundamentals and relative valuations (fixed income vs. equity).
Chart to Watch: Normalized 1-Year Chart of Greece CDS (Black) vs. Greece 10 Year Bond Yield (Blue) vs. VIX Index (Green)
disclosure: The opinions expressed in this Weekly Chart Book report are those of the author. The materials and commentary are strictly informational and should be used for research use only. This bulletin is not intended to provide investing or other advice or guidance with respect to the matters addressed in the bulletin. All relevant facts, including individual circumstances, need to be considered by the reader to arrive at investment conclusions that comply with matters addressed in this bulletin. Charts and information used in this report are sourced from Bloomberg.