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Market Outlook: Focus on this Friday's US jobs report

Stock markets remain impressive, constantly setting new records. Last Friday was no exception. In the United States the broad S&P 500 equity index closed 0.9% higher, gaining 1.5% last week and 20% so far during 2021. The Stockholm All Share Index (OMXSPI) began the current trading week with a cautious upturn but then gave up its gain and more. US 10-year Treasury yields are just below 1.3%.

Among the headlines in world media are that the US has confirmed that it has now withdrawn from Afghanistan after nearly 20 years of military presence and that Hurricane Ida has left behind major devastation in Louisiana, where more than a million homes and business lost electricity.

Federal Reserve calms markets despite same message as before

For financial markets, last Friday’s big event was Fed Chairman Jerome “Jay” Powell’s virtual address at the Jackson Hole economic policy symposium. His message was clear. The Fed may begin tapering its stimulative securities purchases from USD 120 billion per month as early as this year. He also stressed that tightening monetary policy too early may be harmful to the economy and that key interest rate hikes are far in the future. If anything, the Jackson Hole meeting led to a sense of relief in markets, despite a message that was consistent with forecasters’ predictions.

Hurricane Ida pushed up oil prices

Crude oil prices climbed to their highest since early August, after Hurricane Ida roared through the Gulf of Mexico last weekend and made landfall near New Orleans. But oil prices now appear to have stabilised, once the storm lost intensity on Monday. Brent crude is now trading at below USD 72 per barrel. It is still too early to assess the damage to US oil infrastructure and output, but there are signals indicating that oil production facilities largely avoided serious damage.

Growing concern about China’s economy

New statistics show that Chinese corporate earnings growth slowed further in July due to material shortages, new COVID-19 outbreaks, cautious consumers and extreme weather. Confirming Beijing’s growing concern about the growth outlook, both the People’s Bank of China and the Ministry of Finance have opened the door to more stimulus measures in the world’s second-largest economy.

Some highlights to look for this week

On September 1 (today) both Swedish and Norwegian purchasing managers’ indices for the manufacturing sector will be published. On September 3, market attention will shift to the US jobs report, with updated employment statistics for August. This may provide clues as to whether the Fed will decide at its late September policy meeting to approve reductions in its monthly bond purchases starting relatively soon.

Our market view

Normalisation will dampen upside potential

The world economy is in the midst of a powerful recovery. The spring and summer months of 2021 have shown the highest growth figures for a long time. This is also apparent from corporate earnings forecasts and stock market performance. The world’s stock exchanges have generally gained around 20% this year (in terms of Swedish kronor) and the Stockholm exchange even more. But earnings forecasts have also been revised upward. At present, the consensus among analysts is that global earnings will climb by more than 45% this year!

Because of sharp increases in earnings, despite share price increases, valuations have not generally risen. Our usual valuation metric – the price to earnings (P/E) ratio – has fallen slightly, making shares "cheaper". From a historical perspective, valuations are still stretched, but taking low interest rates and bond yields into account, today's stock market valuations are defensible.

The fact that valuations have also levelled out probably shows that investors now agree that the economy is moving from the rapid growth of the recovery phase towards normalisation. The world economy will continue to grow, but at a gradually slower pace. With the growth rate set to fall at the same time as major stimulus measures fade, the stock market outlook will be more uncertain. It is thus also reasonable to assume that P/E ratios will hardly climb in the future (= higher valuations). They are more likely to keep moving lower and also "normalise" as the economic growth rate diminishes.

But lower growth rates and subdued valuations do not mean that stock markets will fall. Because of continued ultra-low interest rates and bond yields, there is a lack of alternatives and an acceptance of higher valuations than historically. Combined with good (albeit lower) future earnings growth, this should be enough to justify higher share prices, though not price surges of the kind we have seen during the recovery phase this past year.

Assuming that interest rates and yields do not rise too much and too fast, this situation suggests that growth stocks with good expected profit generation may perform well. Given the attention attracted by the sustainability field and the major investments that need to be made, there will probably be a lot of winners among companies that are contributing to a more sustainable world. After sharp price increases last autumn and winter, many of these companies – especially in environmental technology – have had a tough time in terms of price performance. Given their long-term potential, this should probably be regarded as a reasonable correction that will generate buying opportunities for long-term investors.