Purchasing managers’ indices start to appear
A wide variety of manufacturing sector PMIs have begun to be published, with China leading the way. Continued high figures are expected, although forecasters believe they will show some declines. On February 1, newly published Swedish figures showed that manufacturing PMI rose slightly to 62.4 after having fallen for three straight months. This was better than consensus, which expected a continued decline. PMI figures above 50 suggest economic growth.
The United States
Clear signals from the Federal Reserve
The Fed obviously intends to take back lost ground in its battle against uncomfortably high inflation. Based on these signals, we now expect five key interest rate hikes by the Fed this year and a few more during 2023. This implies that the federal funds rate will reach 2.00-2.25 by the end of 2023. During the summer of 2022 we also believe that the US central bank will begin the process of trimming its balance sheet.
ECB and Bank of England announcements
On February 3 the European Central Bank (ECB) and the Bank of England are expected to make monetary policy announcements for the euro area and the United Kingdom, respectively. We expect no changes in ECB policy; instead the focus of market attention will be on comments about inflation, growth and the future outlook for policy changes. The British central bank, however, is expected to tighten its monetary policy further.
The Nordic countries
Swedish krona in the spotlight
The Swedish krona has been in the spotlight after falling to very weak levels last week. On February 1, SEB’s analysts wrote in Nordic Alert “We believe that the SEK is long-term severely undervalued versus the EUR and USD and therefore see current levels as long-term attractive to hedge/sell these currencies versus SEK.”
Our market view
Worries pushing down equities
This year's initial stock market declines have stabilised in the past few days and share prices have rebounded. A downturn after last year's sharp and almost completely uninterrupted rally is not so surprising. Corrections occur at irregular intervals. If we compare today's share prices with those of exactly one year ago, global equities have risen by almost 25% (measured in SEK) and the Stockholm exchange by about 20% − despite recent declines.
Virus transmission, geopolitics and inflation are negatively affecting the stock market mood
There are reasons why equities have performed weakly. Rising uncertainty is one important factor. The sources of concern that are currently the focus of market attention are the rapid spread of COVID-19, geopolitical uncertainty centred on Russia’s dialogue with the West and high inflation, with its impact on the actions of central banks − especially the US Federal Reserve (Fed) – as well as the global growth outlook.
As for the spread of the coronavirus, the situation in our societies is worrying: no doubt about it. But the world has learned to manage the impact of the pandemic and balance its own responses. To the extent that economic growth is affected in the short term, it is likely to regain lost ground as the world reopens. In recent days, there have also been signals from the World Health Organisation (WHO) that include the hopeful message that after Omicron, life may largely return to normal.
Security policy developments in our region of the world are also worrying. The situation is serious, but historical experience suggests that this type of unpleasant conflict rarely has any major effect on growth, other than perhaps locally. Nor is the market mood usually affected, other than in the short term. If diplomatic efforts do not bear fruit, however, there is a risk that Russian military action against Ukraine will be followed by harsh Western sanctions, which in turn may affect Europe's already over-extended energy supply. In a generally risky stock market climate, this would contribute to uncertainty, although its long-term effects would hopefully be limited.
Key issues for the stock markets right now are inflation and the monetary policy changes signalled by the US Federal Reserve. At consumer level, inflation has risen to its highest levels for decades − in the US currently around 7% and in Sweden just over 4%. Much of this is explained by more or less temporary effects, such as rising energy prices. But even if we look at “core” inflation, it is troublingly high. To some extent, this can be explained by the rapid reopening of economies last year.
We and most other analysts expect the inflation rate to fall back this year. But forecasts for underlying inflation have been raised, even a bit further into the future. Most central banks have an inflation target. According to current forecasts, inflation will be at or above their targets, creating upward pressure on low key interest rates.
This is especially clear in the US, where inflation is high (and the labour market is surprisingly strong, which is also part of the Fed's target picture). The reaction from the Fed is also clear. The central bank has accelerated its tapering of stimulative bond purchases and is now signalling significantly more key interest rate hikes, at a clearly faster pace than anyone had expected just a few months ago. Furthermore, if the Fed not only stops its purchases but also starts to shrink its bond portfolio in the future, this would create an additional risk of higher bond yields and greater market volatility. Rate hikes are likely to be implemented despite today's stock market turmoil. The Fed has previously been concerned about rising asset prices, and this may be viewed as a welcome correction. However, the Fed can adapt the pace at which it downsizes the bond portfolio to reflect incoming data and current market conditions.
Aside from leading to higher interest rates and yields, there is an obvious risk that high inflation may also dampen private consumption and thereby hold down demand in the economy. Many analysts are now adjusting their growth forecasts downward a bit, so far not dramatically, but this still adds to the risk picture.
Good underlying growth, in spite of everything
The above account may sound pessimistic about the stock market outlook, and there is no question that headwinds and risks have increased. As a result, we have also gradually reduced the level of risk in the portfolios we manage. But we still have a certain overweight in risk assets such as equities. This reflects the fact that underlying growth is good, in spite of everything, and that rates and yields remain low.
The market's average forecast points to global corporate earnings growth of 5-10% this year as well as in 2023. As for global economic growth, the latest Nordic Outlook report, published on January 25, adjusts SEB’s 2022 GDP forecast around a quarter of a percentage point lower. But we still expect economic growth to be well above the historical average − the recovery is continuing.
Bond yields, which have risen somewhat amid this year’s initial turbulence, are likely to continue upward, but not too rapidly. If that forecast proves correct, fundamental conditions remain rather favourable for equities.
Time for value shares?
Another thing we have seen in stock markets lately is large rotations – re-allocations between sectors and “styles”. After several years of strong performance and higher valuations for so-called growth shares – with the world’s digital dragons in the drivíng seat − last year more cyclical and typically lower-priced shares (“value shares”) took back some lost ground. Despite this, valuation gaps are still wide from a historical perspective. Value shares also often perform better in periods of rising bond yields.
Stockholm is among the worst-performing stock exchanges early in 2022. To some extent, this is because it was among last year's winner, which drove up valuations. But in Stockholm, too, value companies have been quite resilient. Meanwhile the high-valuation companies that drove last year’s upturn have performed more weakly.
Fundamentally optimistic outlook provides support
Turbulent periods like this one often need some time before fading from the system, especially if there are as many unanswered questions as today. Stock market turmoil may persist for some time. But today’s biggest losers are mainly the companies that showed last year’s fastest-rising share prices. Some growth-oriented companies saw extreme price increases last year, and from that perspective the decline is almost a sign of health. Given today’s less favourable upside potential, we do not believe last year's strong positive trend can be repeated. And despite their plummeting share prices, many of the smaller growth companies in particular still carry high valuations.
We expect stock markets to show some volatility. Declines often give rise to a period of adjustment and risk management. Further declines in the near future cannot be ruled out. But our still fundamentally optimistic outlook should provide support for share prices. As the news headlines shift in a slightly more positive direction and the temporary effects of Omicron and inflation dwindle, there is a chance of decent returns once the dust settles.