Market commentary: Is the correction over?

We have witnessed a reversal of recent trends over the past two weeks which has eaten a chunk out of profits for traditionally long only portfolios of bonds and equities of European investors. More pain was piled on for those investors which have positions in US equities, as the dollar has weakened against the euro lowering their total returns, despite the S&P 500 hovering around all-time highs.

The market remains divided over whether the current rout is over. What is certain is that it has definitely slowed down and some analysts are saying the worst is over. Treasuries look fairly valued given the outlook for inflation and interest rates. Options traders which were convinced a bund-market crash was all but inevitable less than two weeks ago have scaled back most of those bets.

Goldman Sachs Group Inc. warns that government debt is still expensive, but a growing number of investors are finding value after the four-week exodus sent yields soaring. Prudential Financial Inc.’s Robert Tipp is buying because tepid U.S. growth will keep the Federal Reserve on hold, while Europe remains too weak to sustain higher yields.

The fact remains that central banks in Europe and Japan, are still buying billions of dollars in bonds each month, and some argue that not far from now we could be looking at back and saying that this could have been an attractive entry point.

Ten-year U.S. notes posted their first weekly gains since April 17, while German bunds pared some of their losses. That lessened the pain of a selloff that shaved off hundreds of billions in market value from sovereign debt in the developed world.

The retreat first began in Europe as signs of inflation emerged with the ECB’s most-aggressive quantitative easing yet. Yields surged, especially in markets such as Germany where negative rates prevailed, then quickly spread around the world as Federal Reserve Chair Janet Yellen suggested bonds were overpriced.

In Germany, where average yields for the entire market dipped below zero for the first time ever last month, bunds soared to 0.78 percent before falling to 0.62 percent Friday.

Market data supporting a trend reversal into a bear market remains very feeble in my opinion, and I would subscribe to the thought that these are attractive entry levels, and we shouldn’t see much more near term downside; and here’s why.

Not only has a raft of U.S. economic releases from retail sales to consumer confidence and factory production been so disappointing, the data hasn’t nearly been strong enough to trigger the kind of inflation what would prompt bond investors to demand much higher yields.

Lower inflation and tepid growth in the U.S. still mean there’s less room for the Fed to surprise the market, unlike in 2013. That’s when Bernanke shocked investors with his comments about reducing the Fed’s bond buying and prompted them to move up their projections for when near-zero rates would end.

In Europe, the only form of data which was slightly encouraging was an upward revision of forecasts for inflation to not be deflationary, hardly the case for a massive policy turnaround.

In Germany, alarm over deeper declines have dissipated. The relative cost of bearish options versus bullish contracts on bund futures has plunged since reaching an unprecedented high on May 7, data compiled by JPMorgan Chase & Co. show. This was seconded by BNP Paribas SA and Societe Generale which affirmed that higher-yielding sovereign debt in the region will recoup much of its losses.

This article was issued by Simon Psaila, Trader/Analyst at Calamatta Cuschieri. For more information visit, information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.

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