Trading CFDs - are financial markets close to a serious correction?

Bond yields are close to record lows, while stocks are hitting all-time highs. What could possibly go wrong?

Financial markets may be displaying signs of stress, even if it’s not all that obvious.

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Stock Market Bubble?


The bulls have well and truly taken over. US stocks are rising, with the Dow and S&P 500 notching up a series of all-time highs last week. Are the prices justified? Jim Cramer says they are, but it’s increasingly a sign of the inversion of usual economic principles. Bonds are just too pricey so investors are piling into stocks. And it’s central banks that keep this pattern going. Even though the US pulled the plug on its asset purchases two years ago, the spill-over from Europe and Japan is hitting the US market.

Partly what we are seeing in US stocks is part of a wider flight to quality as the economy is a beacon of light amid a sea of gloom. Japan is moribund, Europe stagnant and the UK could be heading for a recession after voting to leave the European Union.

Corporate earnings are hardly stellar – the S&P 500 is currently trading well above its 10-year average of 14.7x forward earnings. David Rosenberg of Gluskin Sheff explained to Financial Post that valuations have reached “extremes for the cycle”, noting that they are 21x last year’s earnings and 18.3x next year’s earnings.

So-called safe stocks are a particular case. As JPMorgan suggests in a recent note, valuations for high dividend, low volatility equities are extremely high and the bank predicts the bubble is ready to pop.

Easy credit is fuelling gains. Standard & Poor’s data showing debt of S&P 500 companies has risen 56% in the last five years is indicative of the situation – bonds issued to fund share buybacks that are inflating valuations.

Larry Fink, the BlackRock chief executive, thinks the rally for US stocks will be short-lived if earnings disappoint. Carl Icahn says the “day of reckoning” is near. With volatility on the S&P 500, as measured by the VIX, or fear gauge, sinking to its lowest in two years, something will break, sooner or later. The task for investors is to consider just how far this bull rally can last before it snaps.

Meanwhile Jeffrey Gundlach, DoubleLine Capital founder, believes the fact that equities are at record highs and bonds yields at all-time lows is a sign of “psychosis” in the markets.

“There’s something of a mass psychosis going on related to the so-called starvation for yield,” he said in a webcast. “Call me old-fashioned, but I don’t like investments where if you’re right you don’t make any money.”

Banking Sector Creaking

 

Banks may be in better shape than they were in 2008, but there are deep concerns about the health of Europe’s financial institutions. Italy’s banks are saddled with €360bn in bad loans – around a third of the Eurozone’s total. They’ll need recapitalisation and EU bank stress tests out on July 29th could show up some real weakness. Meanwhile the once mighty bond trading giant Deutsche Bank is limping along, burdened with huge derivatives exposure and ultra-low interest rates biting.

The Stoxx Europe 600 Banks index is down 40% over the last 12 months.

Global Defaults

 

S&P reports that defaults this year have surpassed 100, a 50% leap from the same point last year. It’s the biggest number since 2009 and a worrying signal for the economy. But it seems that it’s mainly oil and energy producers who are defaulting, as they struggle to renegotiate financing after crude prices collapsed at the start of the year.