Stock Market: A fairly advanced revision, but a new turmoil is coming-June 21, 2022 12:40

Fabiana Fedeli, Head of Equity and Diversification Management at M & G.  (Photo provider: DR)

Fabiana Fedeli, Head of Equity and Diversification Management at M & G. (Photo provider: DR)

Fabiana Fedeli, Director of Equity and Diversity Management at M & G

The past few weeks have not been easy for financial markets. Although there are signs of mitigation, the downside risk continues, which can lead to further confusion. Two important questions arise. What are the trends already priced by the market and how should investors position themselves in the face of the variety of possible outcomes?

At the beginning of April, the market was already too generous and did not consider future risks. Potential declines in demand, especially due to rising inflationary pressures, have not been taken into account by market participants. Given the supply-side bottlenecks, possible central bank policy misdirection, and the impact of China’s Zero-COVID policy, growth forecasts are expected to be higher and downgraded.

Early signs of softening demand

Signs of weakening demand have been visible for some time. Household confidence in the UK, Eurozone and the United States has deteriorated since 2021 when the government began withdrawing financial support aimed at combating the effects of COVID.

Despite demand from US households, which has been relatively strong so far, weaknesses are beginning to emerge. On the other hand, in the manufacturing industry, the overall PMI is below 50 (indicating a reduction in activity), but new orders are just in the expanding area.

Are the first quarter results misleading?

The earnings season in the first quarter was relatively mild. This does not mean that demand remains strong. The first quarter was widespread in rearview mirrors. When we hear from business leaders about their expectations for 2022, the situation is not very positive. In the US, UK and mainland Europe, many companies are warning signs that consumers are starting to cut back on purchases, are becoming more and more sensitive to promotions, and demand for durable consumer goods is slowing. I am observing that there is.

End of market self-satisfaction

Since early April, the stock market has fallen sharply and bond yields have risen. But over the last few weeks, stock markets have hesitated and rebounded, and bond yields have fallen. Can you guess that all the bad news is already taken into account in the price? Only part. Most price adjustments have already been delayed, but downside risks remain, especially in the stock market.

The market will inevitably be more sensitive to good news. This could be a partial resolution of the war in Ukraine, a slowdown in inflation, or even greater caution by the central bank in terms of monetary tightening. Bond markets also benefited from rising inflationary pressures and growth concerns that exceeded the outlook for central bank policy tightening.

But the risks remain. For example, additional sanctions imposed on Russia, such as natural gas, disruption of demand leading to recession, the possibility of over-tightening of monetary policy by central banks seeking a balance between inflation and growth, and most importantly, The impact of all this on corporate profits. The central question is which of all these factors is integrated into the stock market price. A priori, prices have taken into account the worsening outlook and a significant slowdown in growth, but the decline remains particularly high for certain stocks that remain highly valued or for which a decline in profits has not yet been considered. Is possible.

The significant recession that has occurred in Europe and caused by new sanctions on natural gas will lead to further declines, especially in the stock market. A credit market recession or collapse like 2008 is not expected and does not constitute our core scenario. In other words, potential rebounds in the market depend on data releases and news and can be short-lived.

We talked a lot about the evolution of equity and bond correlations. We see that the two asset classes move in opposite or similar directions, depending on whether growth or inflation is a top priority for fixed income investors. When comparing yields, stocks still look clearly cheaper than bonds. However, everything depends on the outlook for future earnings.