Markets this year, and especially these last few weeks, seem to be saying contradictory things. Major equity markets have shown no clear direction with non-trivial volatility. While on the other hand, debt markets seem to show a bearish global growth bias. There are many reasons for each of the markets to have done what they have done, some are noise, some are transitory shocks, and others are ex-post creations to fit the facts. Then there are the few important underlying fundamentals. Despite all the noise otherwise, we continue to believe that the global business cycle is the driving force, where US growth, China’s deceleration and Europe’s recovery play crucial roles. In the last few weeks, data has been marginally more mixed than before.

In May of last year, US interest rates were at the low end of the recent range when they started a violent move upwards, mostly as a consequence of the Fed discussing openly the possibility of reducing its asset purchases (which the markets initially interpreted as the beginning of the end of monetary stimulus). The low of 10-year US Treasury rates in 2013 was around May 1^st at 1.69%, and since then it went up to end the year at 3%. The first 100 bps move happened fairly quickly and produced significant volatility in markets, especially in emerging markets where the fear of secular outflows caused drastic moves in most asset prices. Despite that scare, core equity markets ended 2013 with impressive results. During 2014 the picture has been different. Since the first days of 2014 the 10-year UST rate fell from 3% to below 2.5%, while core equity markets have shown only volatility but no real direction (DowJones is down about 1% for the year, S&P500 up about 1.5%, but the Nasdaq down almost 2%). By looking at rates, one would think that something changed this year with expectation about the business cycle and its effects on monetary policy. Equities do not necessarily disagree, but some would argue that given their high valuations if global growth was to suffer there is serious downside.

The first quarter of this year shows an impressive coincidence of bad economic data, producing an estimate of global growth for the quarter of a 1.7% annual pace, which would be just slightly higher than the 1.5% registered during 2Q12, which was the worst month of the European crisis (the EU is 21% of the global economy). The data on the first quarter of 2014 is still being produced, but it is likely to be an anomaly in global growth given its coincidence of bad performance across regions (except for Japan). Emerging economies showed very weak results, to a large extent as a result of the slowdown in China, also coinciding with a particularly bad 0.9% pace for the US economy (where weather played a key role). The current and following quarters are likely to show economic performance closer to trend growth.

Data from companies is not as bad as economic data. The 1Q14 earnings season in the US and Europe showed a better picture, with a fairly high percentage of outperformance. If global growth ends up converging back to trend and prove 1Q14 was a temporary blip, then earnings could show decent growth relative to 2013, which could justify a year with positive returns, though not of the magnitude of last year. One can argue that this earnings data and its outlook justify why equities have not followed step-by-step the apparent pessimism of the rates markets. It is also important to note that on rates there is a profound debate going on about where the medium-term trend should be, whether the old 4% area is now too high and policy rates would only converge to somewhere in the 2-3% range. This debate is not only key for the pricing of debt markets, but for all other assets as it affects the present value of all cash flows.

There are many issues and shocks to observe on a daily basis, but the underlying fundamentals change less frequently, and it will take some time for economic data to provide enough guidance about this and the next quarters. In the meantime, short-term issues will move markets up and down, and the calendar might produce a reduction in liquidity (as it usually happens in the northern hemisphere summer). One cannot be totally immune to short-term gyrations, as sometimes they last a few months. But it is key to maintain our sight on the underlying fundamentals, and those do not yet point to a change in the slow improving trend. However, China’s deceleration and the challenges it presents to it internal reforms and rebalancing is maybe the key risk, and the one markets know the least.