Unexpected reaction after last Thursday’s inflation figures
Last week was dominated by major movements in both fixed income and stock markets. US inflation came in higher than expected on Thursday, October 13. Many observers expected a negative reaction after the announcement, and this did occur − briefly. Shortly afterward, the market unexpectedly surged, with some equity indices gaining more than 5% from their lows during the day. This rebound must be viewed in the light of consecutive declines during the preceding five trading days. But for the Federal Reserve, the new US inflation figures for September (including +8.2% for the consumer price index year-on-year) mean that another key interest rate hike of 75 basis points now looks set in stone for the central bank’s next policy meeting in two weeks.
British U-turn
During the rest of this week, the United Kingdom will remain in the spotlight. The British government has been trying to repair confidence in its fiscal policy and restore financial stability. The new Chancellor of the Exchequer, Jeremy Hunt, spent the weekend revamping the government’s previous heavily criticised mini-budget. On October 17 he announced a policy U-turn − slashing the proposed budget deficit by GBP 32 billion. This seems to have caused the market to breathe a sigh of relief. As expected, UK yields fell sharply and the pound regained ground after Mr Hunt’s announcement. The UK will remain a focus of market attention this week, with British inflation figures for September being published today, October 19.
Focus on quarterly reports of companies
In addition, financial markets are of course focusing on corporate reports regarding third quarter 2022 performance. US stock market sentiment soared on Monday, October 17, with a positive report from Bank of America helping to lift the S&P 500 by 2.6%.
In Sweden, the first Q3 reports have also started to come in. The industrial engineering group Sandvik was the first of the OMXS30 companies to announce its quarterly results, with a report that was stronger than expected. So far, the initial reactions to Swedish quarterly reports have been positive, but in light of low expectations. Analysts had sharply downgraded their company forecasts, and it will be interesting to see what corporate managements say about the future and how this will affect the market. If it does not create so much stress in the market, this indicates that a lot has already been discounted. A weakened krona will also have a positive impact on the earnings of Swedish companies that have significant exports and a negative impact on US-based firms due to the strong dollar.
Our market view
US inflation figures published on October 13 showed continued high inflation, but this announcement triggered an unexpected market reaction. Several stock indices climbed more than 5% from their lows for the day – even though the Federal Reserve will probably have to continue raising its key interest rate to get a grip on inflation. Much of this had probably already been discounted during the stock market declines of the preceding days. Continued rate hikes will increase the risk of a sharper downturn in economic growth, and forecasts of gross domestic product (GDP) growth are continuing to be lowered, in keeping with the same pattern we have seen earlier.
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.