Central banks already talking about reducing stimulus in Europe

Equity markets declined in June to close a successful early year. The upward mo-mentum calmed down after the interest rate level took a slight upward turn, as expected, once the European Central Bank and the Bank of England cautiously started to communicate that the first steps of winding down stimulus would be ahead. The rise in interest rates in Europe clearly strengthened the euro, further widening the equity market return differ-ential across the Atlantic without curren-cy hedging. At the end of June, the return on the S&P 500 index for the euro inves-tor (without dollar hedging) since the beginning of the year was only +1.0% (+9.3% in USD), while the broad Stoxx 600 equity index in Europe has yielded +7.0%. European economies are recover-ing at a solid pace (growth forecast for this year +1.8%) and even the Finnish economy has taken an upward turn. Global economic growth continues to be on a good level, with a GDP growth rate of +3.4% forecast for this year. We have not made any significant changes in our allocation. Equity weight is practically neutral.


– Alternative investments: We will maintain alternative investments at moderate over-weight.
– Fixed income: We will maintain fixed income at neutral weight.
– Equities: We will maintain equities at neutral weight.

Interest rates rose clearly at the end of June in the euro zone. In its recent com-ments, the ECB led on that the current type of stimulus might need to be reduced in future, and this came as no surprise to us. The ECB will end the purchases under its current quantitative easing programme at the end of this year, and by then, it is most likely to announce a reduction of its bond purchases. The most powerful stimulus peri-od will soon be behind us, and, as we see it, the interest rates have already bottomed out. At the end of June, the interest rate of Germany’s 10-year Bund rose to +0.45%, which is still a very low level, while the 5-year Bund is still in negative territory. There is thus room for the interest rates to rise, once economic development and the infla-tion picture improve further.

Globally speaking, inflation is not a threat at the moment. The US has practically full employment, and wage pressure is start-ing to emerge, prompting the Fed to raise the interest rate at least once more during the rest of the year. In Europe, inflation is still clearly below the ECB’s 2% target, and with the current raw material price develop-ment, no dramatic change is expected in terms of inflation during the next few months. However, interest rates are already reacting to the ECB’s statements – even surprisingly sharply. Price volatility in the stock markets has continued to be quite low. In June, the stock market rally calmed down as the stock prices of technology companies, which ex-perienced a strong rise in the early part of the year, especially in the US, fell slightly.

The markets are heading into the Q2 earnings season beginning in July in an expectant mood. On a global level, real economy statistics have no longer been as positive a surprise compared to market ex-pectations as they were in the spring, alt-hough companies’ PMIs still indicate a good level of production in the private sector. There have also been very few profit warn-ings in the lead-up to the Q2 earnings sea-son, so it would be surprising to see earn-ings and especially the subsequent com-ments fail market expectations.

Currently, earnings growth of +10.4% and up to +19% is forecast this year for the S&P 500 index and the European Stoxx 600 index, respectively. A lot of posi-tive expectations have been put especially on European companies, and in the stock markets also, non-European investors have continued to buy European stocks. Political risk has receded to the background in Eu-rope, and the growth outlook is good. The German parliamentary election in the au-tumn will not rock the boat.

Juhani Lehtonen, Head of Fixed Income & Market Strategy Investment Solutions

Market Outlook of July (PDF)

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