October was a strong stock market month, with share prices recovering their September downturn and the S&P 500 closing the month at an all-time high. The fixed income market was different, with rising yields on short-term government securities leading to volatility. Earlier in 2021, discussion focused mainly on how far long-term yields will rise as central banks gradually decrease their bond purchases. In October, expectations of higher key interest rates have taken off instead. The Bank of England has attracted close scrutiny after rapidly shifting its stance and signalling that key rate hikes are imminent. The same is true in other countries that normally attract less attention, such as Canada and Australia. High inflation is a global phenomenon. Central banks in various countries suddenly feel compelled to act – creating uncertainty after their earlier firm guidance.
The Riksbank’s rate path indicates an unchanged repo rate for the next couple of years, but we have also seen large movements at the short end of the Swedish yield curve. Higher short-term yields, resulting in flatter yield curves, have created large headwinds for many funds that are active in that portion of the fixed income market, especially certain hedge funds.
Conclusions from the G20 summit
During last weekend’s Group of 20 summit in Rome, the world’s wealthiest countries approved a global minimum corporate tax of 15%, just as expected. G20 leaders also agreed to pursue efforts to keep global warming below 2.0 degrees Celsius while aiming at a maximum of 1.5 degrees, but made no commitment to achieve net zero carbon dioxide emissions by 2050. During the summit, the United States and the European Union agreed to pause their trade war, with the US temporarily suspending some tariffs on imported European steel and aluminium, in exchange for the removal of retaliatory EU tariffs on motorcycles and many other US-made products.
The UN Climate Conference (COP26) has opened in Glasgow, Scotland
The big United Nations Climate Conference (COP26) opened on October 31 and will run until November 12. The sub-title of the conference is "Uniting the World to Tackle Climate Change". World leaders will try to reach agreement on more concrete actions to achieve the 2015 Paris Agreement targets. In a short-term perspective, we can expect the statements made in Glasgow and commitments agreed by participating countries to result in some financial market volatility.
On November 1 the first major agreement was reached at COP26, with leaders of 100 countries (including Brazil, China and the US) pledging to halt global deforestation by 2030. The agreement also calls for funding to restore felled areas and to protect threatened forest lands. The signatory countries together account for more than 85% of the world’s forests.
The United States
The Fed will make a monetary policy announcement
On November 3 (today), the Federal Reserve will make a new monetary policy announcement. No key interest rate hike appears likely, and the Fed’s decision to begin tapering its asset purchases will surprise no one. However, the pace of the reductions in purchases will provide an important signal about the timing of the US central bank’s first key interest rate hike. US labour market statistics, to be published on November 5, will be another major macroeconomic event this week.
The Nordic countries
Norges Bank will make a key interest rate announcement
On November 4, Norges Bank will attract the gaze of monetary policy analysts with a new key interest rate announcement. The Norwegian central bank hiked its key rate at the previous policy meeting but is not expected to make any changes this time around. The Bank of England will also make a key rate announcement on November 4, after fixed interest markets have closely followed signals from the British central bank in recent weeks.
The Swedish krona is going from strength to strength
The EUR/SEK exchange rate is at around 9.90 for the first time since early 2018. We believe that flows related to dividends and initial public offerings (IPOs) are continuing to be a key driver for a stronger krona − most recently the stock market launch of Volvo Cars. In our view, the currency is also being supported by the Riksbank’s increasingly aggressive pricing.
Our market view
October was a strong stock market month, with upturns of around 5% for both world equity indices (measured in local currencies) and for shares listed in Stockholm. Among the winners were American tech companies and Swedish small caps, while emerging markets generally experienced a tougher month. Because of the rebound, several indices (especially in the US) again showed all-time highs in October, despite weakness in September.
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.