Another action-packed week lies ahead for financial markets. We have a slew of corporate earnings reports, central bank meetings in Japan and Europe, US growth data and the UK Budget. I’ll be discussing all of this and more in my monthly macro webinar on Thursday.
Divergent market movements
Bonds yields rose in all major markets over the last week, they’ve risen even more over the last month and even more than that over the last 3 months. Yet most major equity markets are up over these same time periods. And that’s a pattern we expect to continue. Equity prices up, bond prices down.
Inflation fears have certainly risen, with breakeven inflation numbers hitting multi-year highs in the UK, US and Europe. The 5 year figures 5 years forwards numbers – closely watched by central bankers – are now at 2% in the eurozone for the first time since the currency was launched. And the response? The European Central Bank will reduce its bond purchase programme, the US Federal Reserve will taper, and the Bank of England will be the most aggressive of all with a base rate rise set to be announced next week. That’d be the first rate rise from the Bank of England since February 2018.
If central banks are withdrawing liquidity, why are equities rising?
The answer lies in corporate earnings. As long as these are rising, risk assets should continue to rally. The US earnings season is underway and no less than 165 companies will report this week. The headline figures flatter to deceive with most companies beating on earnings and revenues – even more than normal. But that’s because, for some strange reason, analysts have been aiming low on their estimates. More importantly, the outlook for earnings has been improving. So while soaring input costs, supply disruptions and labour shortages have been hitting growth, companies have been able to push price rises through, protecting margins.
We will see that pattern in US GDP figures for Q3, to be published on Thursday. These are likely to show the slowest growth since the recovery from the pandemic began over a year ago. But that reflects weakness in supply and, to be fair, worries over Covid too. Inventories probably fell in Q3 with a big fall in autos, but fell even faster in Q2 and the way the numbers work, that adds to GDP growth. Final sales were probably flat. Lack of supply allowed auto companies to raise prices.
Winter worries but the worst should be avoided
Earnings are rising so equites continue to rally, but as Covid cases pick up and countries tighten restrictions, will that end the rally as the winter arrives in the northern hemisphere? We think not, and look to the UK, which has the highest case numbers for major European countries. Yes, the numbers are frightening with over 50,000 new cases a day but this pandemic is now dominated by school children. The highly respected infection survey by the Office for National Statistics shows that close to 8% of secondary school children had Covid, plus nearly 4% of those in primary schools. Infection rates in the older groups are around 1%. Since youngsters rarely develop the illness seriously this explains why hospitalisation rates have remained low. The government is now focused on giving booster jabs to the older groups whose immunity from earlier vaccination is waning. Yes, there’ll be a crisis in the NHS this winter, but I do not believe that the worst fears will be realised.
Supply shortages, protected profits and stronger sterling
So, to sum up, the world is learning to live with Covid. Supply shortages are restricting economic growth but companies are protecting margins. Risk assets should continue to rally but bonds look set to underperform. And sterling should strengthen as the Bank of England aggressively raises interest rates. More detail in the 28 October webinar plus a Q&A.
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.