Equity-bond decoupling shows risks have changed
By Robert Cole
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
Investors may be rethinking the inherent riskiness of equities, especially compared to bonds. It’s a logical response to seismic shifts in the euro sovereign debt markets.
Normally, shares would be expected to suffer alongside bonds at these troubled times. After all, equities come at the bottom of the creditors’ pecking order, making them among the riskiest of financial assets. Investors might be expected to flee from stocks since bond market woes reflect, at least in part, fears of recession.
But leading equity indexes such as the Stoxx 600 and MSCI World have suffered only modest falls recently. US shares show gains over in the short and medium term. And the latest Bank of America Merrill Lynch survey of fund managers suggests that equity market sentiment is improving, especially in the United States.
Several factors sustain hope for shares. On one side, the crisis has cut into the appeal of bonds. Euro zone sovereign risk, once thought vanishingly small, has grown. Even if there are no defaults (other than Greece), the possibility makes all bonds look relatively more risky, and shares relatively less so.
Meanwhile, companies on average have strong enough balance sheets to stand aside from what is essentially a debt crisis. Aside from financial stocks – which investors would do well to treat separately just now anyway – companies tend not have exposure to government bonds.
True, the weakening economic outlook means that corporate earnings growth may slow. But Thomson Reuters’ Starmine database suggests that year-on-year earnings, globally, will rise 11.8 percent over the next 12 months. Commercial life in Europe may be tougher, but if continuing euro zone woes prompt concerted intervention from, say, the European Central Bank, euro shares could draw benefit alongside bonds.
For multinationals, exposure to global industrial consumer markets is a plus. In general, corporate cashflows underpin – though still do not guarantee – valuations. Compared to historic norms, those valuations suggest shares have limited scope for further declines, barring complete catastrophe. And the prices of traditional safe haven assets – U.S. Treasuries or gold for instance – are so high as to look as if they are riding for a fall.
Equities aren’t invincible. But they are pretty well equipped for these rough times.