Last week financial markets were again volatile. Sweden’s most liquid listed stocks (OMXS30) gained 1.7% between October 14 and October 21, while the Euro Stoxx 50 index was up by 2.8% and America’s broad S&P 500 index climbed 4.7%. The fixed income market was even more volatile, with 10-year US Treasury yields closing at 4.22% on Friday after dropping below 4% early in the week.
In the United States, S&P Global’s flash composite purchasing managers’ index (PMI) for both manufacturing and services fell more than expected, pointing towards a gloomier economic outlook. This fuelled stock market gains in the US and Europe, based on investors’ hopes that the Federal Reserve will slow down its rapid key interest rate hikes later this year.
Rishi Sunak takes the baton from Liz Truss
Financial markets also cheered when former Chancellor of the Exchequer Rishi Sunak finally took over from Liz Truss as prime minister of the United Kingdom. Despite Truss’s record-short period in office, she was the first PM since Winston Churchill to serve two monarchs – something to put on her CV. The news that Sunak was taking over as PM triggered both lower government bond yields and a stronger British pound, but yields are still above their level before Chancellor Kwasi Kwarteng unveiled his now infamous mini-budget in late September.
Q3 reports have not stressed out markets so far
We are now amid the most intensive phase of third quarter corporate reports. Disappointments are triggering severe punishment, but markets entered the report period with low expectations, so the stress on markets has been constrained. So far the banking sector has reported a favourable Q3 thanks to higher interest rates, which have helped push up net interest income. In the United States, Goldman Sachs, Citigroup and JP Morgan Chase published strong reports alongside Bank of America, which we mentioned last week. In Sweden, Handelsbanken reported the top results. Nordea also performed well but was a bit overshadowed by Handelsbanken. And today SEB also reported earnings well above market expectations. This week we are seeing reports from tech giants such as Apple, Amazon, Microsoft, Alphabet (Google) and Meta (Facebook).
Macrodata from the euro area and Sweden
This week the euro area is a major focus on the macroeconomic agenda, with the high point being the European Central Bank (ECB) monetary policy announcement on October 27. Like financial markets and nearly all other analysts, we assume that the ECB will hike its key interest rate by 75 basis points. Any signals about what the euro area central bank intends to do with its bond purchases will make Thursday’s press conference very interesting. This past Monday S&P Global released its composite PMI for the euro area, which fell again in October.
Statistics Sweden will publish its gross domestic product (GDP) indicator for the third quarter of 2022 on October 28. We expect a slight downturn (-0.2% quarter/quarter, while the Riksbank foresees +0.1 q/q), partly as a reaction to an unexpectedly strong Q2. The National Institute of Economic Research will publish its Economic Tendency Survey on October 27; we expect a continued downward trend, confirming that Swedish GDP will keep falling during the next few quarters.
Our market view
In recent days, we have seen some recovery in the stock markets. Since prices bottomed out in June, this is the third rally, though with market declines in between − so overall prices have been largely unchanged since the summer. Stock market volatility can be explained by a tug-of-war between such macroeconomic factors as growth, inflation and interest rates, which have gradually deteriorated, equity valuations that have come down to what might be considered reasonable levels and investor positioning that has been very negative at times.
Macro factors continue to worry the markets. Inflation remains troublesome, while continued key interest rate hikes increase the risk of a sharper slowdown in economic growth, and there have been continued downgrades of GDP forecasts − the same pattern we have seen before.
Many investors have become anxious, mirroring the downturns we have seen. It is hard not to get caught up in this anxiety, but a negative attitude among investors is, if anything, a buy signal. After all, the downturn we have seen is the market's way of adapting to tougher times. Much of the misery we are seeing today has already been discounted, and asset managers as a group are clearly holding a lower than normal proportion of equities in their portfolios.
Most investors seem to be counting on a mild recession – a relatively short period with a significant but manageable slowdown in economic growth. If things turn out worse than this, it will justify new market downturns, and vice versa.
We, too, expect a mild recession. Looking back at history, it is common for overall share prices to fall by somewhere between 25-35% in such cases: about where we are now. That suggests it is too late to sell.
Many forecasts (including ours) indicate that the worst will come this winter, with inflation peaking and growth bottoming out sometime around the end of 2022. Over the course of 2023, inflation will then start to fall and economic growth will accelerate. And since the stock market is forward-looking this suggests that in any event, a buying opportunity is approaching.
But right now the market is clearly worried and we are seeing a lot of headlines about inflation, central banks and other factors which indicate that things may turn out worse than investors expect. This may trigger further declines. During major crises we have seen stock prices fall by 50% or more, so there may be some way to go. Again, this is not our main scenario, but the risk is there and implies that it may be too early to buy.
Despite market concerns, this fairly balanced picture justifies our current view on risk-taking. We have a largely neutral risk profile in our portfolios, with good risk diversification across and within asset classes. If our main scenario proves correct, markets should be close to bottoming out, suggesting that investor increase their portfolio risks during the fourth quarter. In the short term, as usual we are closely monitoring developments and are also prepared to reduce our risk-taking if the outlook deteriorates further.