Asset valuations are becoming more extended, making risk assets such as equities and below investment grade debt vulnerable to a near-term setback. For the past five years, risk assets were fundamentally cheap, providing a cushion against market noise and periodic setbacks. We are transitioning into a period, though, in which bargains are much harder to come by in many of the major asset classes. High yield debt and corporate bonds, in particular, appear overbought at current levels. Although these markets are not exhibiting signs of a bubble, stretched valuations make these asset classes more sensitive to bad news. Despite the favorable longer-term economic outlook, investors should be prepared for the type of price volatility, which is characteristic of more mature bull markets.
A State of Complacency
The Citi Macro Risk Index, calculated based on credit spreads, swap spreads, and implied volatility on major asset classes, is often used to measure risk aversion in global financial markets. This index has tracked closely with the S&P 500 over the past few years, however, the correlation broke down in January of this year. Despite an increasing level of macro risk driven by uncertainties in the eurozone, U.S. equity indices continue to climb to new highs.
S&P 500 INDEX VS. CITI MACRO RISK INDEX
Source: Citigroup, Bloomberg, Guggenheim Investments. Data as of 3/22/2013.
Economic Data Releases
Continued Strengthening in U.S. Housing Data
- Existing home sales in February reached an annual pace of 4.98 million, the fastest in more than three years.
- The S&P/Case-Shiller 20 city home price index was up 8.08% from a year earlier in January, the best result since June 2006.New home sales fell 4.6% to an annual pace of 411,000, making January and February the best back-to-back months of sales since 2008.
- Durable goods orders jumped 5.7% in February from January, with aircrafts comprising most of the gain. Orders excluding transportation fell 0.5%, after a 2.9% gain last month.
- First time unemployment claims rose less than forecast to 336,000, keeping the four-week moving average at a five-year low.
- Regional Fed indices were generally positive, with the Philadelphia Fed rising more than forecast. The Richmond Fed index had an unexpected decrease.
- Leading indicators were up 0.5% in February, with eight out of 10 components contributing to the gain.
- Consumer confidence, measured by the Conference Board index, fell in March to the lowest since November 2011.
Weak PMIs and Sentiment in the Eurozone
- Eurozone composite PMI fell in the March advance reading, with both manufacturing and services showing an accelerated contraction.
- Eurozone consumer confidence ticked up in the March advance reading, from -23.6 to -23.5.
- German advance PMIs were weak, with a contraction in manufacturing activity and a weaker expansion in services.
- The German IFO business climate indicator dropped to 106.7 after four months of increases.
- Both the manufacturing and services PMIs in France were lower than forecast, showing no improvement in the pace of contraction.
- Italian consumer confidence reached the lowest level on record in March, 85.5.
- U.K. retail sales excluding auto fuel climbed 1.9% in February, the best one-month gain in nearly two years.
- The HSBC China flash manufacturing PMI was better than expected for March at 51.7 versus 50.4 in February.
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