Although the flow of economic and earnings data has continued to beat expectations in recent weeks, the financial system must still be repaired before a sustainable recovery can occur, cautions BCA Research.

“Our global leading economic indicator and boom/bust index have both ticked higher, albeit from historically depressed readings,” BCA reports in a research note.

“Similarly, purchasing managers’ surveys and business confidence measures appear to have bottomed across the developed world, after free-falling late last year. Even last week’s release of the Fed’s Beige Book highlighted that the level of economic activity remains extremely weak, although slightly less so than the previous report.”

“Still, the economy has merely shifted from falling off a cliff to sliding down a slope. The latter is certainly less terrifying and justifies the unwinding of Armageddon trades but is hardly bullish,” it cautions. “Risk assets may continue to move higher from oversold levels over the next few weeks but sustained upside will require evidence that the spate of positive second derivative of growth indicators will turn into a meaningful recovery.”

“Aggressive fiscal stimulus in most countries, combined with the potential for a positive inventory adjustment, should stabilize GDP growth in Q3 and Q4. However, an ongoing improvement in growth conditions will be reliant on fixing the global banking system and credit channels, allowing liquidity to begin flowing to the real economy,” BCA adds.

“While our financial sector stress index has eased modestly, it remains extremely elevated. Similarly, bank lending surveys have improved but standards are not yet easing,” it notes.

“Policymakers will need to continue acting aggressively for the recovery in risk assets to persist. We are positioned modestly in favor of reflation but prefer taking bets in fixed income spread product rather than equities due to relative value and a better yield pickup in case a sustainable upleg takes time to develop,” it concludes.

IE