Equities noticeably cheaper

Halfway through October, the equity markets experienced a significant downward correction practically throughout the world’s main stock markets. The slight dwindling of economic growth, the calming down of trade flows and the uncertainty caused by the trade war have contributed to the sales pressure on equities.
All in all, the Q3 earnings season met with expectations in the US; earnings growth is approx. +20%, which is still very good. In Europe, China and the emerging markets, equities that are usually sensitive to economic cycles have shown weak development this year and the prices of many equities have fallen significantly. Assuming that the global economy does not plunge into a downturn and earnings growth conditions do not weaken to any great extent, many equity markets are clearly having a sale. Read more about the positioning of our allocation products in the current situation in our Allocation Insight.

The upward pressure on longer-term low-risk government bonds has settled down in the euro zone and relented slightly also in the US. The monetary policies of the major central banks have not provided any surprises in recent weeks. In the US, the Fed is continuing with its interest rate hikes and we predict that the central bank will decide on a 3% key interest rate hike in this rate-hike cycle. In Europe, in turn, the ECB is ending its net purchases on the bond markets at the end of the year and will move over exclusively to reinvestments when bonds mature in the balance sheet. So far, the ECB has offered no comment on the weighting of reinvestments (long vs. short bonds). This twist element has been used successfully by, for instance, the Fed, with the US forced to boost its economy once again after its net purchases. The first interest rate hike by the ECB is expected in September or October 2019, meaning that short Euribor rates are anticipated to remain negative for months to come.

The euro bank system, generally speaking, still seems to be experiencing massive overliquidity. There is plenty of money on hand. According to our projection, Sweden’s first interest rate hike will occur in December this year and Norway has already carried out its first hike for this cycle. Of the major central banks, only Japan is behind the ECB in terms of interest rate hikes. Currently, within fixed income investments, we favour floating rate corporate bonds and, generally speaking, a proactive approach to interest rate risk management.

The US equity markets hurtled their way up to their all-time highest peak in late September but in mid-October experienced their first major correction since January-February this year. In the wake of sales pressure, this year’s equity returns fell by more or less half in the US. The earnings season is underway and companies’ earnings have remained very positive in the US. Compared to a year earlier, earnings growth is looking to end up at approx. +20%. However, companies have been moderate in their comments and cautious in their trade war communication. Next year, earnings growth of some +10.5% is projected for S&P 500 companies. In Europe, more profit warnings have been given and comments have been even more cautious than in the US. Earnings growth of +9.2% is forecast for Stoxx 600 companies for next year, which will probably be revised slightly downward as the Q3 earnings season moves forward.

Earnings growth expectations for EM countries for next year are still around +11.8%, which is fairly high. China’s growth forecast is calming down and interest rate levels in EM countries are rising in order to tackle the depreciation of currencies. The United States’ main front in the trade war is China and, unfortunately, there does not appear to be a quick solution anywhere in sight. The protectionist measures are impeding and slowing down global trade flows and the impacts can already be seen on a wider scale. The investment appetite of companies is usually one of the best indicators – based on earnings comments, it is waning slightly at the moment. Nevertheless, global economic growth is in good shape, at a current growth rate of around +3.6%.

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

Market Outlook of August (PDF)

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