Macroscope | Market sell-off is both overdone and warranted

Fears of a global recession are stalking financial markets.

On Tuesday, European equities fell to their lowest level since October 2013 as investors rushed into the safe haven of government debt, with the yield on Japan’s 10-year government bonds dropping into negative territory for the first time.

Banking stocks have been on the sharp end of the deterioration in sentiment, with the shares of Credit Suisse and Deutsche Bank, two leading European banks, plummeting some 40 per cent since the beginning of this year, dragged down by weak earnings, weak profitability and the prospect of very low (and in some cases negative) interest rates for a considerable period of time.

A plethora of vulnerabilities that have been weighing on sentiment - persistent concerns about China’s economy and policy regime, the economic and financial fallout from the plunge in oil prices and mounting uncertainty regarding the outlook for US monetary policy - are now feeding on each other, fuelling a wave of bearishness centred around the financial sector.

The question is whether the pessimism is justified.

Clearly the severity of the deterioration in sentiment since the start of this year - a 15 per cent decline in eurozone stocks, a 55 basis point fall in the 10-year Treasury yield and rising bets of a US recession this year - is disproportionate to the catalysts for the sell-off - all of which were firmly in place well before the beginning of 2016.