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Market Outlook: Higher long-term bond yields and cloudier economic prospects

The Swedish all-share equity index (OMXSPI) lost 2.9% during the week ending October 1, while in the United States the broad S&P 500 index declined by 2.2%. Ten-year US Treasury yields climbed from 1.454% to 1.541% before retreating late in the week; on October 5 they climbed to around 1.57%.

September was a weak stock market month, with share price downturns both in Sweden and across the Atlantic. We saw higher long-term bond yields and rising inflation, while the US Federal Reserve signalled that it will soon begin tapering its stimulative bond purchases – the latter helped trigger financial market volatility.

Continued crisis for Chinese real estate giant Evergrande

Renewed concerns about China’s real estate development sector continue to weigh down the economic outlook in Asia. Trading in Evergrande shares in Hong Kong was suspended on October 4 due to an announcement that the company plans to sell part of its property management unit to raise needed capital. The Chinese government would prefer to let Evergrande’s share and bond holders deal with the company’s liquidity problems, thereby minimising the negative consequences to banks and other real estate companies.

US debt ceiling and stimulus packages will remain in focus

Two pending federal stimulus packages, as well as the government’s debt ceiling, will probably remain in focus even though neither solutions nor an acute crisis are likely this week. After the Democrats failed to reach consensus, both the USD 1.2 trillion bipartisan infrastructure package and a more controversial USD 3.5 trillion package − which includes social welfare programmes as well as measures to combat climate change − are stuck in Congress. House Speaker Nancy Pelosi is hoping to pass both bills by the end of October.

Oil prices soar after OPEC+ announcement

At its October 4 meeting, OPEC+ (the OPEC oil cartel plus Russia and several other major producers) decided to stick to existing plans to gradually increase production by 400,000 barrels per day starting in November. Directly after this announcement, the price of Brent crude oil futures climbed by 3% and is now at close to USD 83/barrel: a 3-year high.

Worth watching this week

On October 8, the US jobs report for September will be released. As usual, there is great uncertainty about how quickly the American economy will recover as the COVID-19 pandemic slowly winds down. This includes what will happen to household consumption as stimulus payments and unemployment benefits fade. But a weak non-farm payroll figure this Friday is unlikely to affect Fed tapering plans. According to SEB Research’s US specialist Elisabet Kopelman, such market developments as plunging share prices connected to China and/or the US debt ceiling – rather than data on economic activity – are the main factors that might persuade the Fed to postpone its planned phase-out in bond purchases.

 

Our market view

In the past few weeks, stock markets have turned in a weaker performance – driven by the liquidity crisis affecting Chinese real estate giant Evergrande and more recently by the problems of its rival Fantasia, as well as slightly weaker macroeconomic statistics and uncertainty about when and how the US Federal Reserve will begin to taper its stimulative bond purchases. As a consequence of worries about the Fed, long-term Treasury yields have also climbed, fuelling further concerns.

There is thus no shortage of worries, nor is it inherently surprising that stock markets have lost ground after the sharp upturn of the past year. Yet given what we are now know, we do not regard this as the beginning of a long period of major downturns. We anticipate that the Chinese government will intervene in case of continued problems in the property development sector if this is required to stabilise the financial system. Beijing also has the necessary resources. Another reason for concern in China is that the government has been taking clear steps to tighten regulations and limit earnings in various parts of the private business sector. We can expect a lot of uncertainty in China for some time to come, but we do not currently believe that this will have any major global effects. Uncertainty about future actions, however, gives us reason to continue monitoring events in China extra closely.

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. The recent weak performance of stock markets should also be viewed in light of the largely uninterrupted rally we have seen in recent quarters; in itself, a correction is not surprising.

It is also important to bear in mind that right now we are in the midst of a powerful economic recovery, bolstered by extreme stimulus measures. Looking ahead, the pace of economic growth is likely to slow gradually and eventually approach more normal figures – our guess is during 2023. Meanwhile major stimulus programmes will probably be phased out gradually, so we can expect massive support for risky investments to be smaller in the future.

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 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. In recent days we have also reduced the proportion of riskier (high yield) corporate bonds in our fixed income portfolios from a large overweight towards a more normal weighting. But we still hold slightly more equities than in a normal situation. This reflects our view that the volatility we are now seeing will not affect the long-term outlook. If share prices should continue to decline, buying opportunities may arise, but we are not there yet.