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Market Outlook: The ghost of stagflation is haunting financial markets

  • Inflation figures for various countries are being released this week
  • Household expectations of Swedish home prices are falling
  • SEB has published a new Nordic Outlook research report

We are leaving behind another gloomy week of downturns on many stock exchanges. Between April 29 and May 6 the broad S&P 500 equity index in the United States performed reasonably well, losing only 0.2%. Meanwhile the Stoxx Europe 600 index retreated by 4.5% and Sweden’s All-Share Index (OMXSPI) lost a full 6.1%.

Last week the US Federal Reserve raised its key interest rate by 0.5 percentage points and indicated that it planned similar rate hikes in the months ahead. Ten-year US Treasury yields climbed to as high as 3.13% last week but dropped back below 3% on May 10 (yesterday).

Parallels with the stagflation era − expansionary fiscal policy, increased acceptance of price increases and rapid inflation in some countries − are being pointed out more and more by market observers.

The World

Inflation figures for various countries are being released this week

On May 11 (later today), US inflation figures for April will be announced. The consensus forecast is that the consumer price index (CPI) will fall to 8.1% year-on-year from its March level of 8.5%.

April inflation figures will also be announced for India, Argentina, Russia, France and Spain later this week.

Yesterday Denmark reported a CPI of 6.7% in April − the highest since 1984 − due to spiking electricity and heating prices. Meanwhile Norway reported that its consumer prices in April were up 5.4% year-on-year, the most since 2008, while core consumer prices rose 2.6% from the previous month’s 2.1%, beating market expectations. Sweden will publish its latest inflation figures tomorrow (Thursday, May 12).

The Nordic countries

Household expectations of Swedish home prices are falling.

The SEB Housing Price Index fell by 21 in May, from 39 to 18. This number reflects the difference between the percentage of respondents who expect home prices to rise or fall during the coming year. Household expectations about the Riksbank’s repo rate one year from now rose from last month by 0.23 percentage points to 1.36%.

New Nordic Outlook!

See the May 2022 issue of Nordic Outlook by clicking here.

Our market view

The following is an excerpt from SEB’s Nordic Outlook research report, published yesterday, May 10.

A risky balancing act

The size of downward revisions in economic growth and corporate earnings will determine the long-term potential for equities, during a year when central bank expectations are controlling the short-term stock market mood. A soft landing − without either large further interest rate and bond yield upturns or overly weak growth − are discounted on stock exchanges, where the most aggressive share valuations have been lowered. If this balancing act is successful, there is hope for decent stock market performance.

In the first four months of 2022, stock market conditions have increasingly come to resemble a pessimist's Christmas. Rising inflation, interest rates and yields, downward adjustments in economic growth forecasts, continued disruptions in global supply chains, soaring energy prices, a tragic war on European soil and forceful pandemic lockdowns in China – the factory of the world − are creating great concern among investors.

The normalisation of rates, yields and monetary policies is largely welcome. But aside from pushing down growth, troublingly high inflation is of course creating the risk of bigger key interest rate hikes. The surge in bond yields raises the question of when fixed income investments will come into play. Our forecasts point to moderately rising yields, which need not trigger any stock market drama. In recent years, interest support has turned into a headwind for stock markets.

It is worth noting that because of rising yields and wider credit spreads, running yield for an investment grade US bond index has climbed to above 4 per cent. The corresponding figure for high yield bonds is nearly 7 per cent. As yields reach increasingly investable levels, the TINA (There Is No Alternative) argument is weakened.

Global economic growth forecasts are being dialled down, and not only by us. But so far this has not had a major impact on aggregate corporate earnings forecasts. Global earnings forecasts for 2022 have only been lowered marginally this year: from +8-9 to +5-6 per cent. Forecasts for 2023 are stable at around 8 per cent. This year's forecasts may well be lowered further, but if these forecasts hold, they will help sustain share prices, especially since price/earnings ratio valuations have generally fallen in recent quarters.

Positioning provides support. Not only are companies continuing to show good adaptability, but a more cautious approach and positioning by investors is also providing reasonable support for share prices. Expectations have been lowered, and professional investors have reduced risk in their portfolios by holding a higher proportion of cash equivalents and a lower proportion of equities than the historical average. In equities, they are overweighting more stable sectors such as pharmaceuticals at the expense of industrials. Geographically, they are more cautious about Europe, which is logical given geopolitical and growth concerns.

Among this year's losers are previous winners − growth companies. This means that bloated valuations for these companies have come down and the historically wide gap compared to other market segments has narrowed. This is most evident in smaller companies with the very highest valuations, but global digital dragons Facebook/Meta, Apple, Amazon, Microsoft and Google/Alphabet (FAAMG) also follow the pattern.

With storm clouds overhead and unusually powerful forces in motion, we expect stock market performance in the coming months to be determined by the news about inflation, central banks and economic growth potential. There are major challenges, including the risk of higher inflation, rates and yields if central banks are unsuccessful in their battle against inflation. Another risk is that growth will be squeezed towards recession, eroding corporate earnings and justifying lower share valuations. But if inflation can be curbed and if growth forecasts hold up, we see potential for stock markets to deliver a reasonable return given the risk.‌