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Market Outlook: A turbulent week on the world’s stock exchanges

Last week ended in negative territory after a turbulent period on the world’s stock exchanges. In the United States the broad S&P 500 equity index fell by 1.9% from December 10 to December 17, while Sweden’s All-Share Index (OMXSPI) lost 1.0%. The STOXX Europe 600 performed somewhat better, with a downturn of only 0.3%. Last week 10-year US Treasury yields dipped as low as 1.40% but have recovered in recent days (December 20-21) to above 1.45%.

The world

New lockdowns due to increased COVID-19 transmission

The Omicron variant of COVID-19 is rapidly spreading around the world, prompting many countries to impose new restrictions or even lockdowns. In the Netherlands, only essential activities will be allowed to remain open as the rest of the country shuts down until mid-January. In London, United Kingdom Health Secretary Sajid Javid declined to rule out further restrictions in the coming days and weeks.

Despite increased economic uncertainty, last week several central banks took steps towards tightening their monetary policies. Both the Bank of England and Norges Bank hiked their key interest rates, while the US Federal Reserve decided that its stimulative asset purchases will be phased out twice as fast as before. In the euro zone, the European Central Bank (ECB) announced that net asset purchases in its Pandemic Emergency Purchase Programme (PEPP) will end in March, while its regular Asset Purchase Programme (APP) will expand during the subsequent six months in order to ease the transition. This was completely in line with market expectations. In China the central bank instead lowered its one-year loan prime rate from 3.85% to 3.80% in an attempt to stimulate economic growth, which has slowed.

The United States

President Biden’s “Build Back Better” package at risk of collapse

In a statement on Sunday, December 19, Joe Manchin said he will not vote for President Joe Biden’s “Build Back Better” package, which focuses on social and climate-related reforms. Without the West Virginia senator’s support, it will be virtually impossible for the bill to receive Senate approval. Negotiations on a new version of the package are likely to continue but may lead to tighter US fiscal policy than we had expected.

The Nordic countries

Swedish home prices keep on climbing

Prices of tenant-owned units (mainly flats) rose by 0.4% in November compared to the preceding month, while prices of single-family houses rose by 0.3%, according to Valueguard’s latest HOX Index. Seasonally adjusted, this is equivalent to a 0.9% upturn for tenant-owned units and 1.1% for single-family houses.

NIER releases updated indicators and forecasts

On December 21 (yesterday), the National Institute of Economic Research published its Economic Tendency Indicator, which summarises the situation in the Swedish economy and respondents’ expectations. The indicator edged down to 117.1 in December, compared to 117.6 in November. Of the sectors included in the survey, only manufacturing did not show a decline in December.

Market Outlook will now take a two-week holiday break, returning on January 12. We would like to wish you a truly happy Christmas and New Year!

Our market view

Uncertainty about outbreaks of the Omicron variant initially generated some stock market turmoil, but recent reports about the limited risk of severe illness have had a calming effect and resulted in more stable markets. Although from a human perspective there are continued reasons for concern, we believe it will take a lot more negative news about the new virus strain before it has any major impact on economies and financial markets. This hypothesis is supported by the mild economic effects of recent COVID-19 waves and the fact that after nearly two years of the pandemic, we are learning to better manage any effects.

On the other hand, inflation worries continue to disrupt financial markets. The inflation surge of recent months has been both bigger and more long-lasting than expected, but so far it has been manageable in the markets. The same applies to current forecasts that inflation may climb further early in 2022, before declining. This is still our main forecast and that of most other observers – but it is now being challenged. Though it is unlikely that inflation will get stuck at the unusually high levels we see today, especially in the US, there is a growing risk that it will not fall to central bank target levels (around 2%). Continued inflation at higher levels than this would force central banks to act, including larger key rate hikes than in current forecasts.

This is not our main scenario, however. We are still expecting inflation to fall gradually next year, but partly due to higher inflation levels the US Federal Reserve will unwind its bond purchases faster than previously forecast during the first half of 2022 and will begin a period of key rate hikes during the second half. We believe the federal funds rate will reach 1.5% over the next two years and that 10-year US Treasury yields, a major alternative to equity investments, will reach the 2.5% range. These are yields that we believe are completely manageable for stock markets and investors, especially if our economic growth forecasts prove correct. But looking ahead, worries about larger or faster upturns in interest rates and yields are among the biggest risks to keep an eye on.

In our main scenario the global economic recovery will continue next year, with growth well above the historical average. By 2023 growth will fall to more "normal" levels. This suggests continued good earnings performance by listed companies, which have also shown an impressive ability to generate earnings and manage disruptions in recent quarters.

We thus foresee some continued upside stock market potential for another while, but this presupposes that the Omicron variant can be managed without any major economic effects and that the inflation outlook will not worsen. But inflation in itself is not the only problem; if investors become more and more concerned about inflation, this may lead to rising interest rates and bond yields that have a negative impact on stock markets.

As long as rates and yields do not climb too rapidly, there are solid hopes that positive stock market returns will continue into next year.