Investors Lose Fear of Black Swan as Earnings Impress
Earnings season is in full swing, bringing hopes that the global economy may be on the road to full recovery. Early returns suggest that investors are slowly starting to buy into the scenario that better days lie ahead, unwinding some trades put on at the apex of market pessimism.
To be certain, the jury remains deadlocked over whether the global economy has completely turned a corner. The U.S.'s struggles to resolve its debt troubles loom large in the minds of most investors, while Western Europe still hasn't found a permanent solution to what ails its debt-saddled and withered peripheral countries.
Still, the euro has spiked to its highest level in nearly a year against the dollar, while interest rates in Italy and Spain – the locus of the market's fears about a euro zone fracturing –have fallen by more than two full percentage points. On Friday, ten-year Spanish government yields traded close to 5 percent after surging to euro era highs at 7.75 percent in July.
"What you're getting is a lot of Europe-positive sentiment from the Europeans, which frankly…I would not have expected," Andrew Liveris, Dow Chemical's president, chairman and CEO told CNBC from the World Economic Forum in Davos this week.
"Now it's a relative positive…but people are feeling much better about a European bottom and the potential signs of a Europe that's above zero percent growth, which is phenomenal," he added.
Meanwhile, most major central banks are proceeding full throttle with plans to flood the financial system with cheap liquidity –helping to grease the wheels of a stock market rally. The Bank of Japan's plans to buy massive quantities of bonds has sent the yen plunging, and the Federal Reserve is unbowed from its own quantitative easing efforts – although they did recently warn about inflation risks.
All this takes place against a backdrop of both the Dow Jones and S&P 500 flirting with record highs, and a sharp decline in the price of gold, an inflation hedge and a key barometer of investors' appetite for safe haven. Years of being bearish on the market has led to buying opportunities, some say.
(Read More: The Odd Season: Good Earnings, Nervous CEOs)
"The market has gone up with people being under-invested," Goldman Sachs CEO Lloyd Blankfein told CNBC's "SquawkBox," from Davos. He said investors should want the market to go down "so they can get in."
"The price action in the euro and periphery debt speaks for itself," said George Davis, managing director at RBC Capital Markets in Toronto. "It certainly appears as if those investors have unwound the Doomsday type trade, and tried to accumulate long positions."
As a result, Davis adds that investors are less predisposed to an "outlier or fat-tail scenario" that involves the U.S. either defaulting on its debt, China slowing down sharply or Europe collapsing under the weight of its debt crisis.
That belief is most reflected in U.S. Treasury bond yields, which have inched higher but are still near historic lows. The Fed's massive bond buying is preventing borrowing costs from soaring, while inflation remains contained.
"We still have that artificial plug in the market that's putting a floor under yields," said RBC's Davis. "Under normal circumstances the yields would be higher."
The bond market's relative calm in the face of soaring debt also raises the prospect that investors are still hedging their bets in the event of an unexpected downturn.
Meanwhile, not everyone is convinced bond yields will remain placid. Noted inflation hawk James Grant told CNBC's "Futures Now" this week that while the catalyst for a sell off was not yet present, "bonds simply don't pay you for the risk you take."
Government debt "is trading as if it were going out of style," Grant said. "There's a positive stampede into what I think is the wrong class of money."
(Read more: Interest Rates Will Spike This Year: Soros.)