Financial markets are an important indicator of the health of the global economy. Although fallible, markets provide useful signals on investor sentiment and on expected valuations of the assets traded.
Here is our reading of recent financial market developments.
Since the sell-off in equities last October, the European Central Bank has launched a round of Quantitative Easing and expectations for rate rises have been pushed back in the US and UK. This has provided a very good backdrop for equities.
The ECB's QE programme has boosted prices of risk assets, especially European equities. Germany has been the best performing major equity market, returning 38% since October. French and Dutch equities have also returned more than 30%. In the crisis-stricken periphery, Irish, Italian, Spanish and Portuguese equities have seen big rallies.
This has coincided with upgrades to growth forecasts for several euro area economies and indicates greater optimism over the currency bloc's economic prospects. Indeed, the ECB has recently upgraded its euro area growth forecast to 1.5% for 2015, up from 1% in December.
Falling oil prices and the resulting boost to disposable incomes are expected to support European growth this year. This is reflected in the performance of consumer-facing sectors, which have done especially well, with consumer discretionary stocks such as Italian eyewear maker Luxottica up by 61% and carmaker BMW up by almost 46% since October. As a whole, the German, Italian and Spanish consumer discretionary sectors have returned almost 50% during that period.
Greece's equity market seems to have been immune to QE though. Investors in Greek equities have lost a quarter of their investment since October – a consequence of greater uncertainty over its growth prospects and membership of the euro area, since the ultra-left party Syriza came to power in January.
A mood of caution over growth in emerging markets, coupled with weak commodity prices, has weighed on emerging market equities. These markets have underperformed industrialised world equities for almost five years, though this has come after ten years of huge outperformance.
Falling commodity prices have hit the Brazilian and Russian markets which are down since last summer. Among emerging markets, the performance of India stands out with equities up by more than a quarter since the election of the pro-business Modi government last May. Chinese stocks have also performed well over the same period.
Government bonds have gained in value, particularly in the euro area where QE has propped up bond prices. But as a relatively safe asset, bonds have underperformed equities as investors have looked to take advantage of a stronger growth backdrop.
Commodities and commodity-related equities, such as oil & gas and mining companies, have underperformed the wider market. Oil prices have almost halved since last March, with oilfield services stocks such as UK's Petrofac down by 30% in the same period.
In the currency world, we have seen a marked decline in the euro, fuelled by QE and the general expectation that euro area rates will stay near zero for quite some time. But the big news is the remarkable rise of the dollar, up over 20% since last summer, partly due to the strength of the US economy and partly on growing expectations that the Federal Reserve will be the first major central bank to raise interest rates.
If and when the US Fed raises rates, there is the risk of a repeat of the "taper tantrum" from 2013, when capital flowed out of emerging markets as the Fed announced a gradual slowdown of its QE programme. There is also the risk of rate rises staving off a recovery in consumer spending.
For now though, markets suggest that investors see better times ahead for the western consumer and economies. But successfully managing the transition from an ultra-loose to a tighter monetary policy stance remains a major challenge for policymakers.
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