Zalando in shock guidance cut, equities are lifted from yield plunge

When bad is good

Yesterday’s session was historic with a massive decline in the German 2-year yield falling 25 basis points, the second largest drop since 2005, and the US 2-year yield was down as much as 18 basis points during the session before rebounding again. Interest rates had already rolled over somewhat responding to the decline in commodities signaling a worsening economic outlook. But yesterday’s unusual move in interest rates was likely caused by safe-haven flows as preliminary PMI figures in the US and Europe suggest a much faster slowdown than anticipated. The US PMI composite index hit 51.2 vs est. 53.0 down from 53.6 in May and Europe’s composite PMI figure in June was 51.9 vs est. 54.0 and down from 54.8. The surprising factor was the services sector which is arguably being hit by weak consumer confidence also reflected in today’s surprise guidance cut from Zalando.

Lower interest rates and falling commodity prices are doing two good things to equities. Lower interest rates mean lower cost of capital which is positive for the present value of future free cash flows, and falling commodities are easing the margin pressure which lifts free cash flows or else being equal. So right now, bad figures are good for equities. If we look at forward estimates for earnings consensus is way too optimistic and equities have for the most part only priced in higher than expected inflation and not a recession, which is why we expect a lower leg down in equities when the recession becomes clear to all market participants.