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An end-of-summer puzzle for investors

Stocks have remained relatively buoyant over the summer. Despite the odd sell-off, MSCI’s all-country world index is up around 5 percent since hitting a 2010 low at the end of May.

At the same time, however, bond yields have all but collapsed. U.S. 10-year Treasury yields have fallen around 150 basis points since April and two-year yields are below 0.5 percent.

In Europe, the 10-year Bund yield has lost 65 basis points in the last month alone.

The fall in yields is generally put down to investors looking for safety as growth in the world-leading U.S. economy stumbles. What is happening on stock markets indicates a confidence in corporate earnings that could not be borne out by such a view of the longer term.

“What we have seen is yields coming down on bonds and at the same time the acyclical phenomenon of an equity rally. The question is—are the equity markets right or the bonds?” said Robert Ruttman, emerging markets strategist at Credit Suisse in Zurich.

Noting that the situation has occurred before—he estimates perhaps 10 times in the past two or three decades—Ruttman added: “Usually equities have been right in terms of the global economy recovering sustainably.”

Many do not agree, at least in the near term. Most expect the euro zone to slow in the second half of the year and the data on the U.S. economy has been dire.

Albert Edwards, the long-time bearish strategist at Societe Generale, reckons equity investors are in for a rude shock.

“The global economy is sliding back into recession and they are still not even aware that these events will trigger another leg down in valuations,” he said in a note.

Buying Spree

Heading into the week, caution is clearly the watchword.

EPFR Global fund flow data showed U.S. equity funds surrendering a net $5.4 billion in the latest weekly reporting period and emerging market equity fund flows hitting a 13-week low, although it was still a net inflow.

Money generally went into fixed income assets, including cash money markets.

Reuters asset allocation polls to be released on Tuesday should give some indication of whether this is reflected globally among large investment houses or whether it is simply an end of summer adjustment.

Two major factors, however, are strongly supporting equities—corporate earnings and corporate buying activity.

The U.S. earnings season has been robust to say the least: Thomson Reuters Proprietary Research calculates that S&P 500

companies overall had second-quarter earnings growth of 38.4 percent, 11 percentage points higher than expectations.

But perhaps more significantly, the research suggests analysts still expect solid growth in the coming quarters and that the decline in U.S. economic strength over the summer has not changed their minds much.

Third-quarter earnings growth is estimated at 24.9 percent, down slightly from July estimates but higher than earlier in the year. Fourth-quarter estimates are at 31.8 percent.

At the same time, the past month has seen an explosion of mergers and acquisitions with corporate investors seeming to find value across the globe.

M&A activity in August had reached $228 billion by Friday, not far from the $260 billion record for the month hit in 2006, before the crisis.

Little and large

In the meantime, two events—one big and one small—should focus the attention of investors in the coming week as they head in to September, a month when risk asset losses can be large.

The small is on Wednesday when a short-selling ban on the Athens bourse is lifted. It was imposed in April, when the country’s debt troubles were escalating.

Europe’s sovereign debt crisis has calmed, thanks to a number of policy moves. But things are still considered vulnerable.

The large is the U.S. jobs report for August, to be released on Friday.

It is always a key report for markets and investors because of what it says about the environment for consumer confidence and spending. Jobs are expected to have been cut again following on from a loss of 131,000 last month.

The report also comes on the back of Friday’s downgrade in Q2 GDP growth to 1.6 percent annualized from 2.4 percent by the Commerce Department’s Bureau of Economic Analysis.

One bright spot might be that the latest new U.S. jobless claims fell more than expected, although it remains to be seen whether it was enough to signal serious improvement in the labor market.