This was supposed to be the year global markets moved in sync, Europe following the U.S. with higher bond yields and stock prices. But at halftime things don’t look so simple.
For now, the bet on risky assets beating haven debt is still working in the U.S., although it has lost a lot of momentum. As of June 28, the ICE BofAML U.S. Treasury index was down 1.1%, the S&P 500 up 2.6% on a total-return basis. But in Europe, the opposite has happened: The total return on the Euro Stoxx is minus 1.2%, while German bunds have returned 1.5%.
Incredibly, yields on northern European government bonds are actually lower now than at the start of the year. The 10-year German yield is just 0.34%, versus 2.85% for the 10-year Treasury. The persistent disappointment in European economic data that started in the first quarter has undermined the catch-up trade, even as some themes have played out as expected, notably the U.S. Federal Reserve and European Central Bank both gradually withdrawing from ultraloose monetary policy.
This means the valuation gaps that investors seized on at the start of the year have grown only more extreme. European stocks still look cheap versus U.S. stocks, while European bonds look even more expensive versus Treasurys. Meanwhile, the euro has gone into reverse against the dollar, summing up the way Europe and the U.S. have diverged rather than converged.
The underlying rationale for taking risk and shunning safety still has its attractions. There seems to be little risk of a sharp downturn in growth in the near-term. And there have been some tentative signs of stabilization in European data in recent weeks.
But there are also more concerns to deal with now, including the risk of a trade war and renewed political turmoil over migration. European Union leaders patched together a deal early Friday to help the countries facing the biggest problems, but tensions may persist. The troubles in emerging markets have spread, with investors now starting to focus again on China, particularly given the sharp decline in its currency.
That leaves markets vulnerable. While U.S. growth is strong now, there are worries about next year as the Fed tightens further and fiscal stimulus fades. If the bet on Europe catching up is to gain fresh life in the second half, it badly needs signs that growth outside the U.S. is solid. With the U.S. expansion already so extended, the clock is ticking.
The catch-up theme is logical, but events just keep getting in the way. It may prove as elusive in the second half as it has been in the first.
Write to Richard Barley at richard.barley@wsj.com