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Market Outlook: Rising inflation, falling yields and new stock market records

Stock markets around the world have continued to climb, reaching record levels in many countries. In the United States the broad S&P 500 Index gained nearly 0.5% last week, and in Sweden the OMX All-Share Index (OMXSPI) also rose by 0.5%. US shares (the S&P 500 and Nasdaq Composite) closed at new record highs on Monday, June 14, before retreating slightly. Sweden’s OMXS30 index of leading stocks also began this week with record highs.

Higher US inflation and lower Treasury yields

Although May inflation in the US was above expectations − 5.0% year-on-year − with core inflation (excluding food and energy prices) at 3.8%, American stock indices reached new record levels while bond yields fell. The 10-year US Treasury yield dropped to its lowest since early March (around 1.45%). This decline is a signal that the market regards recent higher inflation as transitory.

Biden’s European tour

The main message of last weekend’s Group of 7 (G7) summit in Cornwall, England was that the US is back as a key participant in international cooperative efforts. High on the summit agenda were green investments, but G7 leaders also discussed such issues as a minimum corporate tax, donations of COVID-19 vaccines to other nations, the role of the affluent G7 countries in global politics and their stance towards Russia and China.

On June 14, US President Joe Biden went on to attend a North Atlantic Treaty Organisation summit in Brussels − with the clear aim of rebuilding frayed relations with European military allies. The meeting largely focused on Nato’s attitudes towards China and Russia. Biden then joined a European Union summit in Brussels on June 15 that focused on resolving US-EU trade issues. Today (June 16), he will meet with Russian President Vladimir Putin in Geneva.

Swedish inflation outlook

Because of high electricity prices, the inflation rate in Sweden is expected to remain close to the Riksbank’s 2% target throughout 2021. Base effects (comparisons to year-earlier prices) and a lower weighting for international travel may explain the dip in Swedish inflation that is expected to occur this summer.

 

Our market view

Recovery will support stock markets

The underlying stock market trend remains slightly positive, supported by relatively strong economic statistics. We are thus not making any changes in our market view below.

Partly due to worries about inflation, stock markets have paused to catch their breath, but this development should be seen in light of their strong performance earlier in the year. The upside surprises that predominated in corporate earnings reports for the first quarter were not generally rewarded by higher share prices, but they still provide hope for strong earnings growth ahead. Also contributing to such hopes are robust macroeconomic statistics, especially purchasing managers' indices.

Strong investor faith in a coming economic recovery is providing continued support to stock markets. Another contributing factor is that the upturn in US Treasury yields has levelled off. Most observers, including us, expect further small upturns in yields during 2021 and believe that sharp earnings increases among listed companies will provide sufficient support to share prices.

Excessively rapid and/or large yield increases may of course disturb this scenario. Likewise if production disruptions − such as the semiconductor and other component shortages reported by many companies − have an impact on corporate earnings. Despite these risks, we are sticking to our cautiously optimistic view of stock markets.

In our main scenario, we anticipate a clear economic recovery starting this spring or summer, with solid growth at least well into 2022.

In an economic recovery, cyclical value companies should be able to regain some lost ground, but looking further ahead the digitisation trend will continue to benefit growth companies. Sizeable worldwide investments in sustainability suggest that last year's strong performance for companies with this type of strategy may continue.

Share valuations today are undoubtedly high from a historical perspective, but can be justified by lower interest rates and bond yields as well as a strong earnings outlook. These high valuations limit upside potential in the long term, but they are rarely a good signal to sell in a short-term perspective.

Continued potential, though a lot has been priced in

Given today's low interest rates and yields, it is hard to find good alternatives to stock market returns. Meanwhile, central banks and governments have established a floor by promising continued stimulus.

This suggests that the growth picture will have to become much worse, causing downward adjustments in companies' earnings forecasts, and/or yields will have to climb much more than expected, for major stock market downturns to materialise. Recent market upturns naturally increase the risk of profit-taking, with downturns of 10% or perhaps 15%, yet we expect stock market indices to be a little higher this coming autumn than today.