03/05/2013 at 6:11 pm

What an interesting year it is turning out to be.

This afternoon, stronger-than-expected employment data from the US surprised markets, driving equities to new record highs and causing bonds to sell off …

… But not all bonds. Government yields in Spain, Portugal, Italy and Greece have reached new lows for the year. 10-year Italian debt looks set to spend its first week below 4% since November 2010 – and this when a new prime minister has just announced he’s sick of austerity and wants to take some tax hikes off the table.

Safe haven bonds have held their ground well, the equity rally has seen huge regional variation and gold has made up a considerable amount of the ground it lost in its massive downward splurge last month. But we have been seeing real signs of a return to confidence – in some cases, even, a return to reason – in financial markets that have been challenged by serious events and which in recent years might have been expected to have reversed as a result.

We have spoken before about a “tug of war” between the US and Europe. If the US recovery keeps its pace and we see a return to growth on the other side of the Atlantic too, then the focus of this game will change.

There has been a lot of comment about a supposed “Great Rotation” from bonds to equities this year, and use of the phrase “risk on” whenever there are signs of this. The fact is though that this rotation / risk revaluation has been highly selective. European equity has lagged, as have the major emerging markets (three of the four “BRICs” are down YTD, with the exception of India, where the Nifty 50 has sputtered all of 0.7% higher). And even with this afternoon’s moves, benchmark bond yields in the US, the UK, Germany and Japan remain lower than where they ended 2012.

A sustained return of market confidence and a continued absence of macroeconomic catastrophe should see more of a “rotation” in appetite for risk than we have had so far: not just bonds-into-equities, but “safe” equities into markets, sectors and strategies which are still feared; spread compression in credit markets that is mirrored to a greater extent by drifts downward in over-bought government bonds … There are those who regret having missed what they see as a surprising rally in risk, but in fact this has been sufficiently limited for plenty of opportunities to remain should momentum build, broadening the spectrum of risk revaluation and making price behaviour elsewhere more consistent with what we have seen on the stock exchanges of New York, London and Tokyo.

It is true that this has been a frustrating, difficult and indeed hair-raising recovery. Market confidence could still quite easily come unstuck. But it is surely an equal truism that by the time everyone has regained their confidence, lost their fear of setbacks and decided to buy, risk markets really will be overpriced.

This is likely to take some time. And in a few months, of course, it might well look with hindsight that we should have all sold in May and gone away. Otherwise there are still opportunities out there – for now.


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