Stocks reach record highs on positive earnings and a rally in oil prices. The S&P gains 0.2% to 2,112 after reaching an intraday record of 2,120. The Nasdaq reaches a new record as Microsoft, Amazon, and Google all post favorable earnings reports. The Nasdaq currently trades at a multiple of 30, compared to the long term average of 27.8. When the Nasdaq last reached this level at the peak of the tech bubble in 2000 the multiple was 190. Supporting the positive sentiment in markets was Brent and WTI prices, which have reached their highest point so far this year. The dollar falls 0.7% as jobless claims and new home sales both come in worse than expected. The U.S. 10 year yield retreats to 1.95% following several days of gains. Internationally both the eurozone and China PMI fall unexpectedly. Also, China is now currently growing at an annualized rate of only 5.3% compared to their target 7%. On the prospect for decreased demand, aluminum falls 2.1%.
The difference in Greek bond yields from only one year ago reflect how drastically the country’s outlook has changed. Last April Greece issued €3B in bonds on a 5 year issuance. The country received around €20B orders for this issuance, and this overwhelming demand pushed the yield down below 5%. Tables have since turned as a result of the Syriza party winning the election this past winter. This represents an example of financial markets misjudging political risk. In 2012 when Greece was in a similar situation, their troubles quickly spread to other peripheral Eurozone countries such as Spain, Italy, and Portugal. Since then these risks have been mitigated, with eurozone exposure to a Greek default being virtually entirely unwound. The correlation between Greek bond yields and yields in other peripheral countries has falled. The €60B each month quantitative easing program has helped keep yields low and fears limited. Markets have been relatively calm in recent weeks on the expectation that a Grexit will not occur, and that if it does occur contagion will not spread the problem to other European countries.
The default of Chinese company Kaisa Group reflects an example of the strength of the dollar and its effects on foreign issuers. It is estimated that the international community has around $9T in debt that is denominated in dollars. The amount of dollar denominated foreign debt has more than doubled since the financial crisis. This trend spans emerging and developed markets, both governments and corporations. As the dollar appreciates, these borrowers need more of their domestic currency in order to make payments. This problem has risen recently as the dollar index has increased 13% in the last 6 months, and many expect it to rise further as tightening begins later this year. This effect offsets increases in competitiveness gained from weak domestic currencies. The emerging market corporate bond market (for companies with $ denominated debt) now totals around $2T which is many multiples larger than the $1.6B U.S. corporate high yield market. It’s important to note that as a result of increased regulation on banks, many of these loans have been made through asset managers, insurance and pension funds so the effects of potential defaults are less clear.
Positions taken by hedge funds in recent weeks reflect the idea that they expect the british pound to appreciate following elections. These positions are contrary to the view of Goldman Sachs, which speculates that the pound may depreciate in the event of a hung parliament. Markets have recently expressed that election outcomes will be detrimental to pound value, regardless of the outcome. If the SNP Labour Coalition wins, the outcome will be bad for businesses. If the Tory party wins, the likelihood of a referendum separating from Europe increases. Both of these scenarios would be bad for the pound. However some hedge funds disagree, and have taken on exposure to the pound as a result. Nevertheless, one month implied volatility for the pound against the U.S. dollar is at its highest level since 2011.