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Prieur Perspective: Investors Flock to Risky Assets?

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Stress tests drive up prices for equities, precious metals.

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One of the definitions of "stress" offered by Merriam-Webster is "bodily or mental tension resulting from factors that tend to alter an existent equilibrium."

Well, any bodily or mental tension investors might have been suffering from as a result of financial factors were shrugged off on Thursday with the announcement by US regulators that 10 of the nation's largest banks had to add a total of "only" $74.6 billion in equity following the completion of stress tests. However, whether this will indeed restore the equilibrium remains to be seen.

The diagram below, courtesy of the Financial Times, summarizes the stress-test results in a nutshell.


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As investors welcomed the less-than-feared stress-test results and their hopes for an early economic recovery mounted, they drove up the prices of risky assets such as equities, oil and commodities, precious metals, emerging-market bonds and currencies, and high-yielding corporate bonds. On the other hand, traditional safe havens such as developed-market government bonds and the US dollar experienced selling pressure.

With investors' confidence being buoyed up, the CBOE Volatility Index (VIX) declined by 9.2% during the week to 32.1 - a far cry from more than 80 in October and a sign that markets are returning to more normal behavior.

The performance of the major asset classes is summarized by the chart below.



Marking 9 straight weeks of gains, the MSCI World Index surged by 6.4% (YTD +3.6%) on the week, the MSCI Emerging Markets Index by 9.4% (YTD +27.9%) and the S&P 500 Index by 5.9% (YTD +2.9%). Serving as a reminder of the severity of the bear market, these indices are still down by 43.3%, 45.8% and 40.6% respectively since the October 2007 bull-market highs.

With the exception of the Dow Jones Industrial Average and the UK FTSE 100 Index, most major global stock markets have now moved into positive territory for the year to date.


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Returns around the world ranged from top performers Ukraine (+20.5%), Serbia (+20.0%), Kazakhstan (+19.4%), Peru (+17.9%) and Singapore (+16.6%) to Barbados (-4.1%), Slovakia (-2.3%), Bangladesh (-2.0%), Pakistan (-1.0%) and Tunisia (-0.9%) which experienced headwinds. (Click here to access a complete list of global stock market movements, as supplied by Emerginvest.)

With only a handful of US companies still to report first-quarter earnings, 62% of the companies that have reported have beaten analysts' earnings expectations. According to Bespoke, this earnings season will be the first quarter-over-quarter increase in the "beat rate" since the third quarter of 2006.

"When the 'beat rate' started to decline in 2007, it was definitely a warning signal for the market, and this quarter's increase is hopefully the start of a new positive trend. As long as analysts remain behind the curve, and companies exceed expectations, stocks will have a solid foundation to build on," said Bespoke.



As far as leadership since the start of the 9-week-old rally is concerned, the surging Financial SPDR (XLF) is by far the top performer among the economic sector exchange-traded funds (ETFs). Interestingly, cyclical sectors such as the Industrial SPDR (XLI), Consumer Discretionary SPDR (XLY) and Materials SPDR (XLB) all outperformed the S&P 500, whereas the traditional defensive sectors like Consumer Staples SPDR (XLP), Health Care SPDR (XLV) and Utilities SPDR (XLU) all lagged the broader market. This is the type of pattern one would expect typically to emerge during a market base formation development.


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No positions in stocks mentioned.
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