Oil prices have also continued to climb and are at their highest since 2014 in the US. The main international benchmark, Brent crude, now costs around USD 85 per barrel – the most expensive since October 2018. In Europe, natural gas prices have eased slightly in recent days but remain high.
Federal Reserve’s September minutes confirm tapering plans
The minutes from the latest Fed policy meeting confirmed that the US central bank will make a decision on phasing out (tapering) its stimulative bond purchases at its November 2–3 meeting. In our view, it would take major disruptions in financial markets or in the economy to persuade the Fed to change course now.
ECB considers increasing its purchases of euro zone bonds
The European Central Bank (ECB) is reportedly considering expanding its capacity for buying euro area bonds, enabling it to continue such purchases even after the Pandemic Emergency Purchase Programme (PEPP) expires in March 2022. A number of ECB decision makers are also suggesting that the bank should be allowed to retain the same flexibility regarding the proportion of national government bonds it buys. There will probably be disagreements about the suitability of this type of measure.
The third quarter corporate report season has begun
A number of US listed companies have already report their Q3 results, including several major banks that have beaten market expectations. In Sweden, the report season takes off in earnest this week. On October 19 telecom group Ericsson released its report, which showed core earnings above consensus estimates despite lower sales in China. Several Swedish banks are presenting their Q3 reports today (October 20) and later in the week.
Our market view
The stock market downturn that began in early autumn has reversed during the past week. After global share prices fell by around 5%, and roughly twice that much in Sweden (which outperformed world stock markets during the first half of 2021), most of the decline has now been recovered.
Among the reasons behind the downturn are somewhat weaker macroeconomic statistics than anticipated, while inflation – which climbed during Q2 – has persisted at higher levels than expected. Slower economic growth and higher inflation (=risk of higher interest rates) is undoubtedly a toxic combination for stock markets. Adding soaring energy and commodity prices, China’s real estate crisis and tighter government regulations, global bottlenecks in goods production and worries about the phase-out of stimulus programmes (especially the tapering of bond purchases by the Fed), we have ample explanations for this autumn’s downturn.
In this perspective, the recent stock market recovery may be surprising, but although the outlook is now far more uncertain, there is still fundamentally good potential for equities. Economic growth will remain healthy, although forecasts are being adjusted a bit lower amid the prevailing turbulence, while interest rates are likely to remain low. Inflation is naturally a source of concern – if it gets stuck at high levels, along with continued high commodity prices and so on, it will create clear headwinds. Yet there are indications that many of these effects are related to the reopening of economies after the COVID-19 pandemic and are of a transitory nature.
The Fed is expected to reduce its bond purchases soon, but is also likely to be sensitive to events in global financial markets – for example if problems in China have a larger international impact.
Market turmoil may, of course, continue for some time and new downturns cannot be ruled out. However, we do not expect that what is happening, assuming the situation does not clearly worsen, will have any significant effect on either global economic growth or corporate earnings. The fixed income market has also been relatively stable, and equities will continue to enjoy strong fundamentals – including healthy growth and low interest rates.
In this context, it is important to bear in mind that the economy − and financial markets − are now moving towards a new phase in which powerful and fairly straight-line upturns in growth and corporate earnings during the recovery will now give way to a period of normalisation. During such a transition, problems like the ones we are now seeing often arise. In the short term, the big question for future market performance will be how existing inflation and bottleneck risks play out, along with the corporate earnings and future guidance presented during the current report season. Looking further ahead, the key question will be how the normalisation process is working − how quickly economic growth will fall to more normal levels and how much interest rates and bond yields will climb during this phase of the economic cycle.
In the past couple of months we have signalled a slightly increased level of caution by lowering the proportion of equities in the portfolios we manage. But we still hold slightly more equities than in a normal situation. This reflects our view that growth will still remain healthy during the coming year and that increases in interest rates and yields will be relatively limited. However, the time is ripe to adjust our future expected return figures lower − compared to the sharp recovery since last spring − and to prepare for more volatility ahead, both in stock markets as a whole and between different sectors and styles/types of equities. There will also be upside potential, and all else being equal we should probably view downturns as buying opportunities.