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Market Outlook: Report season sustaining risk appetite

Stock markets continue their steady improvement, with the quarterly report season as a positive driver. In the United States, the broad S&P 500 equity index was up by 1.6% during the week to October 22. Meanwhile the Stockholm All-Share Index (OMXSPI) rose by 2.2%. In the fixed income market, 10-year US Treasury yields peaked at above 1.68% on October 20 but have dropped to a bit above 1.60% early this week (October 25-26).

Oil prices have also kept climbing, with the US benchmark West Texas Intermediate (WTI) back at around USD 84/barrel after a slight dip. In international markets, Brent crude has risen to about USD 86/barrel.

Powell confirms tapering but rules out any rate hike soon

Jerome Powell, chairman of the Federal Reserve, confirmed on October 22 that the US central bank will begin phasing out (tapering) its monthly stimulative bond purchases. Meanwhile he emphasised that he is not considering any key interest rate hikes in the near term. Powell said he still believes that inflation will fall towards the Fed’s 2% target as supply side problems ease, although these problems may persist for longer than the bank had previously anticipated.

Biden legislative package is moving towards a vote

According to media reports, US congressional Democrats are making progress towards reaching an internal consensus on President Joe Biden’s climate and social welfare package, totalling about USD 1.9 trillion. According to House Speaker Nancy Pelosi, more than 90% of the proposal has been agreed and put into writing. The Democrats intend to bring the bill to a vote in both houses of Congress before Biden flies to Italy for the G20 meeting this coming weekend.

Important macroeconomic statistics this Thursday and Friday

Quarterly reports of listed companies continue to dominate the attention of financial markets, but important macro statistics and announcements will soon offer some competition. Tomorrow (October 28) the European Central Bank (ECB) will make a monetary policy announcement. Although no policy changes are expected, it will be interesting to see what the ECB has to say about euro area economic growth and inflation. Third quarter US and euro area gross domestic product (GDP) growth figures will be unveiled tomorrow and Friday. Thursday will be an eventful day for macroeconomists in Sweden, with the release of the National Institute of Economic Research (NIER) economic tendency survey and official GDP growth figures.

 

Our market view

During September, stock markets were dominated by uncertainty, increased volatility and falling share prices – in themselves not so remarkable after earlier dramatic upturns. There were many sources of concern for equity investors after this past summer’s rally. But during October essentially the entire recent decline has been recovered, which may seem rather unexpected. Let us look a bit more closely at the reasons behind these market movements.

Among the drivers of the September downturn were 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 September’s stock market blues.

In this perspective, the recent 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 downward a bit 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 ongoing report season is also helping to sustain share prices. Third quarter corporate reports are continuing to surprise on the upside, though not as much as during the previous quarters.

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, which in itself is probably a signal that investors are not so worried about sharply rising inflation. Equities will thus continue to enjoy strong fundamentals – including healthy growth and low interest rates.

From recovery to normalisation

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 recent 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. In other words, more turbulence may be waiting around the corner, but as long as positive fundamentals persist, we should probably view downturns as buying opportunities.