By Jan Faure
Markets rally on strong US corporate earnings.
September and October are renowned for heightened market volatility, and this has certainly been the case. Stock markets climbed in October, following a dismal September showing, with developed market equities leading the way. In the US, the S&P 500 index gained 6.9%while in Europe the Euro Stoxx 50 index added 5.0%. Emerging markets were less upbeat with the MSCI Emerging Markets index gaining 0.9%.
Generally positive US corporate earnings helped to underpin global equities in October, but concerns remain that high commodity prices, wage costs and supply-chain bottlenecks could hurt company margins down the line. Sentiment could also weaken if investors lose confidence in the ability of central bankers to contain inflation. Major central banks have started the conversation on removing stimulus measures put in place at the start of the pandemic. The euro hit a 20-month low versus the British pound on expectations that the Bank of England will hike rates before the European Central Bank. The Federal Reserve has said it will begin winding down its huge stimulus by the end of the year, while there is a growing expectation that the US Federal Reserve will raise interest rates in mid-2022.
Inflation has gathered pace across the world, driven by soaring energy prices and supply chain disruptions on everything from semiconductors to cars and food. The consensus view only a few months ago that inflation would be temporary has faded. Crude oil has more than doubled over the past 12 months. Oil demand has surged as the global economy recovers from the coronavirus pandemic.
Brent Crude Oil: 1 YEAR
OPEC and its allies (OPEC+) have been restrained in easing their Covid-induced supply cuts imposed last year to reverse the slump in oil prices. The gains in crude oil have been supported by a rally in natural gas, which has boosted demand for oil products as a substitute.
In September, the prospect of higher interest rates put the brakes on the year and a half rally across global stock markets. In October, the focus shifted to quarterly earnings in the US and it has been a strong earnings season with approximately 80% of companies beating profit expectations. Banks and technology companies have performed especially well, while companies in the ‘physical’ economy (manufacturers, retailers and restaurants) have struggled due to supply chain constraints. Businesses that straddle the physical and the digital economy, including Apple and Amazon, have also been impacted by supply chain problems.
There is an expectation that the Federal Reserve will soon lay out its plans to begin reducing monetary aid to markets. The Fed has poured liquidity into markets with asset purchases (quantitative easing) of $120 billion per month for the last 19 months. The Fed’s large-scale QE program has lowered bond yields, causing demand for stocks and other financial assets to rise.
The Federal Reserve Balance Sheet: 2008 to today
The Fed’s QE has played a significant role in driving US stock markets to all-time highs since the Covid pandemic emerged. US companies have had access to cheap funding, which has led to increased share buybacks and capex spending. The property market has also benefitted from low mortgage rates, with US property values 45% above the levels pre the global financial crisis.
Tapering of bond purchases will be a drawn-out process and the Fed has shown that it won’t risk the economic recovery if things don’t play out in a satisfactory manner. Of greater concern is run away inflation which would force the Fed to hike interest rates. As we’ve seen the last two months, any indication of high inflation is greeted with volatility in markets. Nobody wants to see rates increase too rapidly and upend the global economic recovery.
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