Friday, June 5, 2009

We assume the recent equities rally is a function of central banks’ various liquidity ops.

From Alphaville:

The (QE)uropean equities rally and yields

Have a look at this chart, from Citi’s pan-European portfolio strategy team. It shows the performance of European equities and the US yield curve for the past 10 years. There’s a pretty clear trend here — when the yield curve steepens European stocks tend to fall, when it flattens, stocks tend to gain.

Citi - European equities vs European yield curve

That trend, according to Citi, has to do with the economic conditions associated with interest rates — and therefore the yield curve. The steepening of the yield curve would normally mean economic conditions are weakening and interest rates are being cut. The economic slowdown would mean lower earnings and normally, lower stock markets. Likewise, in the flattening yield curve scenarios, short-term interest rates are usually rising, meaning an economic recovery is taking hold. So then there’s a better earnings outlook and a rising stock market. Ta-dah.

What’s striking about the above chart though — is that the current rally in equities appears to — so far — be bucking the historical trend. The US yield curve is increasing, with the spread between the 2-year and 10-year benchmark widening to a record this week, but so are European equities.

We assume the recent equities rally is a function of central banks’ various liquidity ops. Cash is being forced into the system, in one way or another, and it’s finding its way into the equities markets. The question is, will that be able to continue? Or will we soon be reverting back to the historical trend?

Related links:
Allocating, multiplying QE - FT Alphaville
Warning signals: QE rally might be over - FT Alphaville


Don the libertarian Democrat Jun 6 05:04
If short term rates are low, meaning low interest on your investment, and long term rates are rising, signaling a recovery from deflation, then it makes sense to invest in stocks and corporate bonds. That's why QE or CE this time was meant to keep short term rates low, with longer term rates rising. It's working, in the sense that any such correlation makes sense to discuss at all. If it isn't, then please admit that you wouldn't know whether it was working or not.

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