Market Update: Impressed but not shocked

The correction in Bond markets as well as the recovery in risky assets is now well underway. Technicals have all turned relative to June's development as the upward trends in government bond futures have been broken to the downside and the downward trends in equity markets to the upside. Favorable Q2 earnings reports, the ongoing stabilisation in economic growth as well as firming expectations for positive growth during Q3 in the US provide the fundamental backdrop. I do not propose to stand in the way of this train. I maintain the view that 120 should provide a good support area - and entry area for potential longs - in the Bund future during this correction period which is likely to last another 1-2 weeks.
I have been looking for a consolidation in government bond prices since last week (see here) and also suggested that risky assets might recover again (see here) and the development in govies is so far playing out as expected. Also the recovery in commodity prices is in line with my expectations. As the chart shows, the CRB-Index has only moved moderately higher during the past days.

Source: Bloomberg

However, the speed of the equity market recovery has been impressive. The chart below shows the Euro Stoxx 50 index (but the same applies to a lot of the major equity indeces). The downward trend line which guided market movements during the past weeks has been broken to the upside on a closing basis. Furthermore, during a period of only four days, two-thirds of the previous downmove has been corrected again. The positive fundamental news (mostly from the US earnings season) has met with a market that was positioned for a break lower. For one, investors' cash levels still appear high. Furthermore, there has been a lot of talk about a bearish so-called Head & Shoulders chart pattern developing for example in the S&P which seems to have led some technical oriented accounts to set up shorts (see here: Head&Shoulder failure).

Source: Bloomberg

Clearly I see no reason to change my fundamental longer term macro-economic outlook where I expect muted growth and subdued inflation for the global economy and especially the large 'developed' countries (amid an ongoing deleveraging in the corporate and household sectors which will lead to weak demand growth). Essentially, growth on a quarter-over-quarter basis should oscillate around a low but slightly positive level (i.e. below trend) for the next several years. However, the ongoing economic stabilisation in the near term (amid a stop in the inventory correction and increasing effects of the enacted fiscal stimulus) is likely to fuel renewed hopes about a sustainable recovery and combined with still high levels of cash suggests that the current upward movement in equity markets risks surpassing the early June highs.
Therefore, I reiterate that I maintain my defensive asset allocation stance from a more medium-term strategic perspective but would reduce risk temporarily on all fronts.