Counterproductive UK government budget
Last week the British government’s mini-budget attracted a lot of attention. Chancellor Kwasi Kwarteng’s proposed cut in the top income tax rate from 45% to 40% – announced one day after the Bank of England (the United Kingdom’s central bank) hiked its key interest rate by 0.5 percentage points to curb inflation – triggered a storm of criticism. Counterproductive, one might think. Financial markets agreed, and the British pound plummeted against the US dollar while UK government bond yields soared. Even the International Monetary Fund expressed concern that UK monetary and fiscal policies were moving in opposite directions. The IMF called on the government to withdraw its proposed cut in the top tax rate, which it eventually did.
Swedish equities: Worst September for years
Sweden’s OMXS30 index of the 30 most liquid stocks began October in positive territory after the worst September for many years. The All-Share index (OMXSPI) fell by 7.5% last month. In the United States the broad S&P 500 index was down by 9.3%, while the Stoxx Europe 600 declined by 6.6%. But on October 3 and 4, stock markets rebounded after the British government scrapped parts of its September 23 mini-budget.
Double-digit euro area inflation
Euro area annual inflation reached double digits (10.0%) in September, compared to 9.1% in August, soon after the US reported rising core inflation – confirming that the inflation-taming efforts of central banks are far from over.
Manufacturing PMIs reveal weakness
On October 3, S&P Global released its final September purchasing managers’ index (PMI) for the euro area manufacturing sector, which fell to 48.4 compared to 49.6 in August – largely due to weak order bookings and rising energy prices. In Sweden, manufacturing PMI also fell below the 50 mark, which implies weaker growth. US manufacturing PMI was a bit stronger “but continued to signal muted improvements in the health of the manufacturing sector,” S&P Global wrote.
A focus on this Friday’s US jobs report
This week the market’s will focus its attention on the jobs report that the US Bureau of Labor Statistics will release on October 7, which is expected to show an expansion of non-farm payrolls and continued strength in the American labour market. This may increase room for consumption and soften the impact of high inflation and rising interest rates. But rapidly growing employment points to a heightened risk that the US Federal Reserve will keep hiking its key interest rate.
Our market view
At this writing, share prices are rebounding after a very rough September, but the big picture so far during 2022 is that bond yields are soaring while stock markets are plummeting. High and rising inflation, record-sized central bank interest rate hikes, very worrying signals from Russia about the Ukraine war and a European energy crisis are among factors that are causing financial market turmoil.
Many investors have become anxious, and surveys of both professional investor behaviour and the views of private individuals paint a pessimistic picture, which mirrors the downturns we have seen. It is hard not to get caught up in this anxiety, but a negative attitude among investors is, if anything, a buy signal. After all, the downturn we have seen is the market's way of adapting to tougher times. Much of the misery we are seeing today has already been discounted, and asset managers as a group are clearly holding a lower than normal proportion of equities in their portfolios.
Most investors seem to be counting on a mild recession – a relatively short period with a significant but manageable slowdown in economic growth. If things turn out worse than this, it will justify new market downturns, and vice versa.
We, too, expect a mild recession. Looking back at history, it is common for overall share prices to fall by somewhere between 20-35% in such cases: about where we are now. That suggests it is too late to sell.
Many forecasts (including ours) indicate that the worst will come this winter, with inflation peaking and growth bottoming out sometime around the end of 2022. Over the course of 2023, inflation will then start to fall and economic growth will accelerate. And since the stock market is forward-looking this suggests that in any event, a buying opportunity is approaching.
But right now the market is clearly worried and we are seeing a lot of headlines about inflation, central banks and other factors which indicate that things may turn out worse than investors expect. This may trigger further declines. During major crises we have seen stock prices fall by 50% or more, so there may be some way to go. Again, this is not our main scenario, but the risk is there and implies that it may be too early to buy.
Despite market concerns, this fairly balanced picture justifies our current view on risk-taking. We have a largely neutral risk profile in our portfolios, with good risk diversification across and within asset classes. If our main scenario proves correct, markets should be close to bottoming out, suggesting that investor increase their portfolio risks during the fourth quarter. In the short term, as usual we are closely monitoring developments and are also prepared to reduce our risk-taking if the outlook deteriorates further.