The poor results of the expected jobs report last Friday (18K vs 105K consensus) were another reminder of the ongoing slowdown in the global economy. Despite the large surprise, the market reaction should be seen as positive. After opening down 1.4% upon the announcement of the dismal employment report, the S&P 500 climbed 0.76% to pare the day's losses to 0.7%. The same trend occurred in other risk assets like emerging market equities, commodities and high-yield bonds.
According to the PMI reports, the global economic slowdown remains in progress. Given the positive trend in risk assets over the past two weeks, markets are likely to have discounted the end of the slow-down.
Figure 1: Global PMI Indexes
Despite the deal that Greece struck with the EU and the IMF, the risk of greater trouble remains, especially if a recession were to strike Europe. The relative performance of European financials (which hold a good proportion of PIIGS bonds) as compared with the broader European equity market, is continuing on a downward trend. Investors continue to discount an outcome that is likely to be worse than now.
Figure 2: European Financials
At this point of time, we do not expect a recession. There are signs that the economic slowdown is coming to an end; however, it is hard to predict how strong future growth will be. Nonetheless, coming out of the market trough on June 16, we see cyclical sectors outperforming the other sectors. The important consumer discretionary sector is up 9.49%, while the consumer staples rose only by 3.26%, versus the market's 6.19% rise. The fact that the consumer discretionary sector made new highs lend credence to the idea that the current rally still has legs.
Figure 3: Consumer discretionary index
Still we would take advantage of any new high in markets to lighten exposure in risk assets. The economic expansion is beginning to wear thin - margins are lower and financing for the least credit-worthy companies have gotten tighter. It is now time to exercise restraint when investing.
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