Stocks fall ahead of busy earnings week and concerning headlines from Greece. The S&P and the Dow both retreat 0.4% to 2,092 and 17,944 respectively. Earnings season is set to pick up this week, and investors will pay attention to tomorrows retail sales report which projects sales to rise 1.1% from the previous month. In addition the PPI will provide a picture of the inflationary climate in the U.S. and is expected to increase 0.2% from the previous month. In addition to news that Greece is preparing for a default, these factors contribute to cause equity markets to slip downwards today as the VIX rose to 13.94. Historically low yields in Japan and Germany of 0.34 and 0.15% possibly contribute to the downward movement in the U.S. 10 year yield which fell to 1.93%. This idea is supported by the dollar which appreciated 0.1% today against peers and rose to $1.0574 against the dollar. “Commodity currencies” such as the Australian and Canadian dollars fall after exceptionally weak data out of China. Exports fell 15% from the previous year in March against a projected 9% increase. March’s trade balance reflected only a $3.1B surplus against the expectation for a $40B surplus.
Greece is preparing for a default on their debt in the event that no deal is reached with international creditors by the end of April. The Greek government will withold e2.5B in payments to the IMF if they do not reach a deal. Analysts speculate that this could be a negotiating tactic aiming to get more lenient bailout terms. In the event of a Greek default the ECB would suspend emergency liquidity assistance for Greece, which could devastate the country’s financial sector as banks experience heavy withdrawals. In addition, the probability of a Grexit from the eurozone would drastically increase. So far this year e7.2B in bailout funds have been withheld from Greece, possibly to put further pressure on the country to meet and agree to favorable reforms. The Greek government reaffirms that they are trying to find a deal, however the finance minister says that his top priority is to meet domestic commitments and the expectations of his constituents, which in some cases clash with creditor demands.
Quantitative easing in Europe has shifted investor demand into high yield junk bonds, which are considered to be highly speculative. Currently ¼ of eurozone government debt yields negative returns, while 2/3 of investment grade debt yields less than 1% to investors. As a result many investors have turned to the high yield market and are assuming more risk than they would otherwise. A strategist at UBS believes that the high yield market in Europe has been redefined. Whereas before investment grade designation was delineated between BBB and BB rated bonds, now he believes that it has shifted down between BB and B bonds. One half of bonds denominated in euro that are rated BB (and are considered high risk) yield less than 2%. The average high yield issue this year has a yield of 4.35% while junk bond issuance is up 73% from the previous year. Furthermore, leverage of these speculative-grade issuers has jumped in recent months, reflecting enhanced risk. These trends reflect the theme that investors are not being properly compensated for the risks they are taking in fixed income markets.
According to a report from Morgan Stanley, financial sector stocks particularly banks should be an attractive investment in the months ahead. In recent months, bank stock prices have increased along with Treasury yields and the dollar, both of which are expected to continue their upward momentum. In addition, the financial industry is expected to experience big share buy bacts after banks passed the Fed’s stress tests last month. Banks are less affected by currency fluctuations, and Morgan Stanley has observed that each 5% gain in the dollar corresponds with a 1.5% increase in financial stock prices in contrast to a 1% decline for the broader market.
Analysts commissioned by the Fed expect more volatility in fixed income markets, particularly in Treasuries prices. These concerns linger after the October 15th “flash rally” when Treasury prices shot upwards with seemingly no explanation. So far this year, Treasury yields have touched a low of 1.64% and 2.26% which is a relatively wide spread. The Treasury Markets Practices Group which is supported by the Federal Reserve, notes higher volatility and less liquidity in Treasury markets as a result of less presence on behalf of banks and an increase in electronic trading.