The ECB’s successful liquidity operations (LTROs) have reduced Eurozone financial strains minimizing the tail risk of a Eurozone Lehman event.
— John Praveen, chief investment strategist, Prudential International Investment Advisers
March - April 2012
We expect global stock markets to post further gains, supported by: 1) An easing of Eurozone fears with a diminished near-term risk of a disorderly Greek default and Euro exit, while the ECB’s successful liquidity operations (LTROs) have reduced Eurozone financial strains minimizing the tail risk of a Eurozone Lehman event; 2) Interest rate and liquidity tailwinds; 3) Improving global growth outlook outside of Europe; 4) Healthy earnings outlook; and 5) Still supportive valuations though markets are not as cheap now as in December 2011 with strong 2012 YTD gains.
However, the pace of gains thus far in 2012 is likely to be unsustainable and volatility is likely to remain high as several downside risks remain. These include: 1) Greek risks: The second Greek bail-out and debt restructuring deal are likely to be a short-term reprieve, with still high Greek debt/GDP burden and Greek elections due in April. A negative election outcome with no clear mandate and/or a new government reneging on its commitments (to reduce debt) could potentially roil markets; 2) Other Eurozone risks: Further debt rating downgrades of Eurozone countries and banks; Recession in Eurozone and the continued negative feedback loop between the high debt burden and economies in recession; 3) Oil price & geopolitical risks: Continued surge in oil prices with simmering Middle East tensions and risk of short-circuiting the global recovery.
Bond yields are likely to remain under upward pressure as risk aversion continues to ease and economic data surprises positively. Risk aversion is declining after the ECB’s second LTRO eased financial strains in the Eurozone banking system, while Greece’s second bailout and debt restructuring has averted an imminent default and near-term exit from the Euro. Global growth outlook continues to improve with stronger than expected economic data in the U.S. and Japan which is also likely to put upward pressure on yields. Bonds remain expensive relative to stocks despite the strong equity gains thus far in 2012. While bond yields are expected to remain under upward pressure, the rise in yields is likely to be capped by developed central banks keeping rates low and undertaking additional asset purchase programs and liquidity operations.