It’s been an action-packed week for financial markets, and we’ve got more drama to come.
There’s a debt crisis in China and the stock market there is struggling as the economy weakens. In past cycles, the authorities in Beijing would have announced policy stimulus by now and the Chinese stock market would have bounced. We discuss why there’s a delay and explain why Bitcoin is involved.
Base rates look set to rise in the US and UK
The major central banks had their meetings last week and they were uniformly hawkish. Current policy wasn’t changed but both the US Federal Reserve and the Bank of England indicated that they might raise official interest rates earlier than expected.
We’ve been arguing for some time that inflation pressures in the US would need a rate rise early next year and last week’s meeting showed that some members of the Fed take the same view. Lots of the committee’s members will be speaking this week and the markets will be watching closely.
The Bank of England surprised the markets even more because recent UK data has shown a clear slowdown in growth. But the Bank of England reckoned that the slowdown reflected supply shortages rather than weaker demand and warned of rising inflation to come. With news headlines full of stories of soaring household energy bills and queues outside petrol stations, it’s hard not to agree. Base rates look set to rise, my guess is that they’ll go up next spring.
Very easy monetary policy no longer needed
Rising official rates is obviously bad news for bonds, and yields rose last week. I reckon they have further to go. But equities have been resilient. Two weeks ago, I warned that we might get a 5-10% correction but all we’ve had so far is a decline of 4% intra-day and most developed equity markets are still in a bull phase.
That strength owes much to good news on the pandemic. Hospitalisation rates had been rising in the US but are now showing a fall. Much of the rise and the fall occurred in the southern states. Yes, vaccination and mask-wearing rates are typically lower in the south but the weather has also played an important role. The indoor season is the summer in the south – it’s just too hot to comfortably stay outside – so Covid infection rates have fallen in cooler September. September is also an ‘outdoor’ month in the northern US states but that will change in the next few weeks. Expect the good news on Covid to change as winter gets underway. I don’t expect lockdowns to be re-imposed, but people could well turn cautious.
Winter is coming…
Vaccination rates are higher in Europe but the indoor season is approaching for northern countries too so expect another wave of hospitalisations. The UK is enjoying an improvement in new cases, new hospital admissions haven’t risen as fast as expected recently, especially in England. But there are still far more people in hospital with Covid in the UK on a per capita basis than most European countries. Double the number in France and five times those in Italy, Germany and the Netherlands. Covid precautions have reduced the number of available beds in the UK by 6,000, and we started off with fewer beds per capita than most other developed market countries. The crisis here is far from over.
Capex boom bullish for equities
Corporate earnings in developed markets have staged an impressive recovery after last year’s recession, helped by generous policy support. The reporting season for Q3 earnings gets under way next month. Companies should comfortably beat analyst expectations but the markets will be focused on the outlook. Are profit margins set to be squeezed by labour shortages and rising input costs, or will companies boost productivity and maintain profits growth? In the short term, I’m cautious on risk assets generally but looking further out, I’m more positive. There’s a capital expenditure boom in the US and elsewhere, and that is very bullish for equities. So risk assets in developed markets still look attractive longer term, and I repeat my suggestion that a 5-10% correction is possible but would represent a buying opportunity.
My monthly webinar is on Thursday 30 September and I explore these issues in more detail, including a discussion of emerging markets.
Past performance is not a guide to future performance. The value of investments and any income derived from them can go down as well as up and investors may not get back the original amount invested.
The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.