Investors are not ready for good news
Throughout the last six months, I have argued that the financial markets are experiencing a huge correction. The correction comes after a decade of exceptionally low interest rates, and partly very low energy prices in Europe. Since spring, we calculated how deep the correction could be, which continues to remain as “just” a correction; and that is where the rates and the financial markets are right now. An example is illustrated by graph one, which shows the Wilshire 5000, an index including the overall US stock market.
The current important factors in the financial markets will hardly surprise anyone, but the key is to which extent the factors already are priced in the markets.
It is correct that there is a recession-like development on the way in Europe and the USA, though I argue that the stock markets have reacted negatively to this outlook several times. I even deem it possible that the US gets to avoid the worst crisis, which should have a positive effect on Wall Street.
In the US, the decline in growth will be partially forced through by the Fed’s interest rate increases. The next jump in interest rates of 0.75 percentage points will not be a surprise to anyone at all, and another interest rate increase of the same size is also on the cards.
In Europe, the European Central Bank (ECB) is also heading towards more rate hikes. It is not the economic growth that must be slowed down, though the interest rate must rise to a minimum level for natural reasons, and to partially match the inflation level. The German bond market priced in an ECB rate of 3 pct. a few weeks ago, and I do not expect it to go higher in this round. Here, I also expect that investors are already prepared for that development.
Reasonably, the continued high inflation is a joker in the predictions for the direction of the financial markets. Because inflation is still unexpectedly high and the risk of new price increases at all levels is even a growing risk, this supports the negative expectations among investors. One solution is to reduce public spending, which will dampen GDP growth, though the fixed income markets will probably respond positively.
Overview of current political landscapes
The fact that China and the whole of Asia are again moving forward rapidly in 2023 towards very good growth rates is not factored in the stock markets at all. In my view, investors overlook the fact that Asia now accounts for 40 pct. of the global economy.
It certainly contributes to the sour political mines in the West, but the problems in the US and Europe are, after all, self-inflicted. The mid-term elections in the USA on the 8th of November will not solve anything in American politics; and on the contrary, the development does not come as a surprise.
In Europe, the situation is so deplorable that it is one of several reasons for my continued recommendation to underweight allocation to this region. The German government is so internally divided on all issues that it is dysfunctional. In France, President Macron has become a kind of “lame duck”. Meanwhile, no one knows where Italy is heading.
In the UK, the situation is no better. After the British government’s latest chaos surrounding the mini-finance budget, I hope that all political ills have been factored into investors’ expectations, though the political direction is once more uncertain.
Impressions on the global market
The listed companies themselves will be particularly interesting. It will hardly come as a surprise that there will be a decline in earnings for a period among several companies; again, I tend to argue that the market is prepared for this bad news.
On the other hand, global companies will continue to grow and become even more dominant, especially if there is no political power to balance out. I also imagine that consumers will increasingly feel the dominance as companies set the price of their products, determine the quality, and establish the customers’ access to service. I expect this situation to be good for earnings and another example of elements that can be perceived as positive. However, these are not included in the current rates.
If I very briefly and roughly add up my impression of the total investment portfolios, positions, and the underlying assessments in the market, then overall, they are still positioned for a negative market outlook. The nervousness is still noticeable, as also emphasized by graph two, which shows that the famous VIX index is still high. I even estimate that many investors, in reality, do not have a plan at all for a sudden development where more positive elements come into play.
Based on my own experience, these situations are extremely interesting. This is because there is a mismatch between the very strong focus on the negative elements combined with a lack of focus on relatively good or potentially good opportunities.
The entire global financial market may fall into a black hole driven by fear, or if Russia uses tactical A-weapons in the war against Ukraine. This is a risk, but not my primary scenario. Instead, there could be some positive elements/developments that come into play — the question is how soon. And here, I am uncertain.
It could either be within a relatively short time that fits with the end of the major correction in the financial market this year, or the positive development will be seen at the beginning of the second quarter of next year. As mentioned, my assessment is that several investors are not at all ready for good news, should it even come. Therefore, I would rather buy than sell stocks right now, however, I will continue to avoid buying European shares unless the investment is particularly exciting.