February brought a significant shift in the market narrative, as the disinflation theme that had dominated the previous few months gave way to a more bullish view. Two catalysts sparked the change. First, the price of oil rose significantly, reducing downward pressure on inflation and alleviating fears that its earlier fall was signalling a collapse in global growth. Second, the euro area – the major source of economic weakness in recent quarters – generated a series of upside growth surprises alongside an easing in political tension.
Against this backdrop, global equities, U.S. Treasury yields and commodity prices all rose in February, and credit spreads tightened. Collectively these moves supported our ongoing portfolio position to be long stocks vs. bonds. Within equities, market developments in February also broadly matched our views, with U.S. large-cap and euro area stocks (measured in dollar terms) both climbing nearly 6% and outperforming the global index, while emerging markets lagged. On the other hand, the U.S. yield curve steepened, reversing the majority of its January flattening.
Curve gyrations thus far in 2015 have mostly reflected swings in the long end, whereas our medium-term call for a flatter curve rests primarily on the assumption that short-dated yields will rise as the Federal Reserve (the Fed) enters a rate-hiking cycle. Meanwhile, our overweight in U.S. investment grade credit benefited from 14 bps of spread tightening, corroborating our expectation that spreads and bond yields will display negative correlation. In our view, February’s market trends owed primarily to the following factors: Oil, and commodities more generally, found a bottom. Having troughed and begun moving sideways in mid-January, the price of crude oil rose nearly 20% in 1 Chart of the Week Recent signs of stabilization in U.S. inflation bode well for equity market valuations.
This week’s chart shows average P/E multiples from 1948 to the present arranged by inflation environment. On average, multiples have been higher when inflation has been moderate (between 1% and 3%) than when it has been either very low (as in the late 1940s) or very high (as in the 1970s). With current multiples somewhat elevated, a persistent slide in inflation below 1% would have threatened a de-rating. Sources: JPMSL, Robert Shiller, JPMAM; data as at December 2014 (excludes 2008-09). S&P500 P/E (on trailing earnings) and CPI, 1948-present Michael Hood Beth Li Jonathan Lowe Benjamin Mandel David Shairp begun moving sideways in mid-January, the price of crude oil rose nearly 20% in February. Other cyclical commodities, including copper, have behaved similarly.
Although it remains nearly 50% below the June 2014 price, oil’s recent recovery has delivered three benefits to markets. First, oil’s plunge in the second half of last year raised concerns that global economic activity might be unravelling. Any such disaster now appears much less plausible. Second, with headline inflation rates already low in many jurisdictions, falling energy prices seemed like a possible trigger for outright deflation. Oil’s subsequent bounce has lifted market-based measures of inflation expectations and is already flowing through to consumer price data. For example, the preliminary February inflation figure for the euro area surprised on the high side. Third, given the importance of the energy sector in U.S. large cap equities and high yield credit, oil’s recovery has halted a string of downward revisions to earnings forecasts and dampened default worries. Both of these markets rallied significantly in February. At the same time, although gasoline prices are moving off their January lows, we continue to expect households in the U.S. and elsewhere to boost their spending in response to the earlier decline
