February 09, 2016
Another crash in European equity markets - that spread to Asia overnight - and a lot of gloom all around. While the data for the big markets are not good, they are really bad for Greece, where stocks were down 7.9% yesterday, with Greek banks down 24%. Over the course of the year, Greek banks were down 56%.
What seems to be happening is that investors are becoming increasingly gloomy about the global business cycle, together with concerns about the stability of the financial sector. Yesterday's global market rout was led by a near 10% fall in the share prices of Deutsche Bank and Commerzbank. When we read quotes from desperate analysts explaining how all this was out of tune with fundamentals, we were reminded of several previous episodes when people misjudged the power of macroeconomic booms and busts and their impact on the stock market.
The stock market sell-off coincided with investors going into bonds in a classic flight-to-safety movement. While there were relatively large daily variations in yields, the picture is clearer if one looks at the variations over the past week. There one can see large increases in bond yields across all maturities for, say, Italy and Greece, while yields dropped for, say, Germany, France or Belgium. There is also an indication of yield inversion in the short term with 1Y yields generally up and 2Y yields generally down, conventionally an indication of market expecting an economic slowdown in the next 18 months. Analysts quoted by Reuters attribute the "risk off with capital 'R'" behaviour to worries about the impact of the global economic slowdown on the European banks, which is again negatively affecting European peripheral bonds.
And finally, we would also like to point to Olivier Blanchard's excellent analysis on the valuation stocks, which may appear a little ill-timed, but where he nevertheless makes the valid point that equity premiums tend to be higher after a financial crisis, and that they revert back to normal values eventually. On his analysis, US stocks are not overvalued if one accepts current market-based forecasts, and if one accepts that markets were not overvalued in the middle of the last decade. These are big assumptions, worthy of a separate discussion, but his data suggest that various measures of the equity premium today are higher than they were in 2005. He was careful enough not to make any predictions about short-term movements in share prices. But if they were overvalued at the end last year, according to his analysis, they are clearly not overvalued now.
We also have stories on the Greek government's desperate search of a positive narrative; on Erdogan's attempt to blackmail the EU; on disagreements between Podemos and Ciudadanos; on Spanish commentators' critical views of the EU's fiscal recommendations; on the politics of Portuguese fiscal policy after agreement with the Commission; on the declining role of Europe in the French political debate; on whether the German constitution has anything to say about €500 notes and cash limits, and on whether Weidmann has retracted his call for a joint eurozone finance minister.