Reasons NOT to panic!

The proximate causes of the recent sell off in equities (up 4.9 today) have been a material increase in global bond yields, weakness in the US dollar and concerns over inflation.

How seriously do we take these concerns?

• A weak currency is typically good for a local currency stock markets because of the translation effect on earnings.

• There has been no data to suggest that we should be worried about inflation in the US – the core PCE deflator, the broadest measure of US consumer price inflation was at 2% in March, which is believed to be precisely the level which the Fed considers to be price stability!

• Although bond yields have risen materially – 10-year treasuries have risen by 1% from their January low to 5.2% currently – this has happened relatively gradually and does not appear to reflect major concerns over inflation but rather a re-assessment of growth prospects. This is supportive of prospective earnings growth.

The Outlook

The S&P500 is now trading on 15x forward earnings, and an earnings yield (EY) of 6.7% relative to an implied real return of 3.2% from bonds.

The UK market is trading on 12.6x, a 7.9% EY compared with a 2.7% implied real return from bonds.

The Eurozone is trading on 13.8x, a 7.2% EY relative to a 2% implied real return from bunds.

Those with a 3-18mth horizon could use this sell off as a buying opportunity!

The immediate outlook is less clear, particularly ahead of US CPI tomorrow. Technical conditions have been deteriorating somewhat over the last month – notably breadth indicators – but there was nothing particularly extreme. This suggests that the downside on the S&P and FTSE100 is likely to be limited. Similarly, however there is nothing extreme in the very short term to point to a predictable rally. The balance of probabilities suggests that those of a short term bias should probably wait for markets to stabilise.

Bottom line: On a 3-12 month view equities remain attractive: they are relatively good value and trend volatility is low.

And finally……….

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Prometheus from sources: ADM, Barclays Capital, Cazenove, Charles Stanley, HSBC, ING, SocGen, UBS.