What’s Happening to Stock Markets This Fall?

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STOCK MARKETS repeated now familiar patterns last week, moving from one economic data to another. The general theme was that good news for the US economy was bad news for equities because it meant interest rates would either rise more or faster, or both. Conversely, signs of weakness – such as news that a key indicator of US business activity had fallen back to 2020 levels – spawned rallies1.

That’s not particularly good news, but it’s not that bad either. Investors did not capitulate to the fall in the markets in the first half. They seem willing to do what the US Federal Reserve says it is doing. They weigh the pros and cons of economic data as it comes in.

The economic picture that has been emerging lately has serious flaws. Inflation expectations continued to rise over the summer, with banking giant Citi the latest to add a spoiler with its assessment that UK inflation could top 18% at the start of the year. ‘next year.2.

At the same time, recession fears have taken hold. Revised data released this week confirmed that the US economy has contracted for two quarters in a row3. On this basis, the risks of stagflation – low or no growth and high inflation – seem to be diminishing day by day.

Yet for all of this there is a silver lining. US companies have been stockpiling to combat unreliable supply chains in recent quarters. There is now a surplus of inventories, so companies have not been buying as much lately, which has had an effect on economic growth in the second quarter.

Meanwhile, the US economy has been creating jobs at a rapid pace, bolstering household confidence. This is essential for an economy more than two-thirds of which is driven by consumer spending. Retail sales increased by around 10% in July compared to the same month in 20214. These are not hallmarks of a normal recession, although the United States may technically be one.

Just as inflation is going higher than almost anyone dared to fear at the start of this year and economic growth has slowed, events can change and opinions change with them. Markets may well be on the verge of seizing some good news.

For signs of this, take a look at the US dollar. He’s been strong all year and the rest5. This is probably primarily because markets are expecting US interest rates to rise aggressively, but it is also consistent with a flight to quality in an uncertain world. Investors are nervous and the dollar shows it.

After such a steep rise, the dollar could pull back on better-than-expected news and risk assets around the world would benefit. This is only the beginning, but the next Fed meetings could be a trigger. Essentially, investors seem to have already priced in some pretty dire scenarios, narrowing the margin for negative surprises.

The VIX index – commonly referred to as the investor fear gauge – has risen slightly this year, although it remains well below levels seen at the start of 20206.

If interest rate hikes have or are about to slow economies or worse, then inflation rates could fall sharply as well. At this point, investors might be more inclined to rule out a stagflation scenario and reassess markets in terms of low growth versus low inflation over the next few years, similar to conditions in the decade leading up to 2020.

This, of course, is the argument for owning stocks in secular growth companies – those that don’t depend on a strong economy to make profits.

The wheels of change in areas such as electric cars and renewable energy technologies will continue to turn because governments and people are behind them. Cloud computing and data centers, artificial intelligence and factory automations will continue to accelerate as they make businesses more efficient and profitable. Outliers like space science can also present new opportunities.

Presumably, investors who have re-entered the tech sector over the past two months, forcing the US Nasdaq index back into a bull market, are already well aware of this. From the perspective of, say, 2025, the uncertainties of 2022 will have faded and the big US tech companies behind the future will say we told you so.

In the short term, all of these factors are more difficult to appreciate – it’s the woods and the trees, if you will. Deciding on a good starting point for making a new investment is difficult because the outlook is uncertain and the economic and corporate information we need to assess what is really happening is mostly laid before us.

In the case of the tech sector, stocks are already well above their summer lows, which begs the question, is there a risk of buying at a local high? Without a doubt, there are. But even if the worst happens, will any entry point in 2022 look expensive three years from now?

Quarterly corporate earnings season in October will be more scrutinized than ever. Not just for the absolute level of profits, but also for signs of whether or not companies intend to continue hiring more staff. If so, the consumption chart should remain relatively healthy. For now though, corporate earnings continue to grow, which is positive for both economies and stock markets.

Investors can navigate uncertainty using a few simple tools. Regular savings plans are a great way to combat the urge to anticipate market reversals, as they automatically accumulate more units or shares of funds at low prices and fewer at high prices. By starting to save from £200 a month on the Fidelity platform before September 12, investors can currently get £25 cashback. Exclusions and terms and conditions apply.

Staying diversified across asset types and countries is also good advice. Government bond markets have, like equities, been rocked by changing expectations for inflation, interest rates and economic growth so far this year. Ultimately, however, they tend to deviate from stocks over time, helping to provide a buffer during periods of slow growth or recession.

Source:

1 S&P Global, 23.08.22
2 Reuters, 22.08.22
3 Economic Affairs Office, 25.08.22
4 United States Census Bureau, 08.17.22
5 Bloomberg, 26.08.22
6 Bloomberg, 25.08.22

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