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December market view
When trends reverse
Since the world’s stock markets bottomed out in October, we have seen a clear upturn in equities. Meanwhile yields on fixed income investments have fallen a lot, especially for corporate bonds. We have (finally) received good news about the US inflation trend, with the October figure showing a slightly bigger slowdown in inflation than expected. Also on the plus side, there are signals that China may be on the verge of easing its severe COVID-19 restrictions, which are significantly dampening economic activity. We have also received mixed news from the US Federal Reserve. After another large key interest rate hike (0.75 basis points), the Fed has signalled that future rate hikes may be smaller − but also that its peak federal funds rate may be a bit higher than previously expected.

But we have also received a lot of bad news, including sentiment surveys among businesses and households that paint a gloomy picture of the future, including a continued increase in European inflation and downward revisions in economic growth forecasts for 2023.

It does not seem entirely obvious that such a mixed outlook will be accompanied by a rebound in risk appetite. The situation is even more unclear if we consider the latest American labour market statistics, which continue to show stronger conditions than most observers had expected. Is good news (people have jobs!) bad news for the markets?

This sounds more illogical than it is. The Fed is raising its key interest rates to cool off the economy and make inflation fall. An economic cool-down presupposes a weaker labour market. When the labour market turns out to be robust, this pushes up the risk of further interest rate hikes − which may also eventually trigger an even stronger deceleration in the economy.

Our fundamental view of growth, inflation and central banks remains essentially unchanged. We expect a mild recession in the Western world (the US and Europe, including Sweden). We believe that inflation, which has peaked in the US, will also fall in Europe next year and that central banks can thus end their interest rate hikes. This also means that next summer we will enter a phase in which economic growth will accelerate again, while inflation and interest rates will fall. That would be a good scenario for risk assets such as equities. Hope among investors that we are headed in this direction is probably behind the recent stock market rebound (and bond yield decline).

But this picture is tainted by an unusually large number of risks in the form of inflation, an energy crisis, war, COVID-related lockdowns (in China) and more. Given this background, the current market upturn seems a bit risky in the short term. If all the pieces of the puzzle fall into place, the positive outlook may last, but its sensitivity to negative surprises has undoubtedly increased.

In our portfolios and recommendations, we are responding to this situation with a rather neutral risk exposure and with diversification. Uncertainty about developments makes it reckless to bet everything on any one kind of investments. Instead, it is better to spread our risks and opportunities while carefully preparing for the more positive scenario that should materialise once some of the short-term risks have been overcome.


Best regards
Johan Hagbarth
Investments
Private Wealth Management & Family Office
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