Market Outlook June - Always a cloud on the horizon

illustration photo
In the financial markets, there is no such thing as a clear sky. There's always something to worry about. According to the latest global investor surveys, increased price inflation in the US is a new addition to the list of concerns. In our view, it's premature to worry about this. The evidence is too flimsy. We believe that interest rates are on the rise. This prediction is based on the promising growth prospects, but not on the latest data indicating sky-high price inflation. Our market outlook has not changed; we maintain a neutral stance towards equities. We still have a constructive view in the cyclical part of the stock market. We believe that this part of the market stands to benefit the most from the economies reopening.

Equities and real estate are real assets. Earnings and rent income are growing at a similar pace as inflation. As opposed to nominal bonds, where interest income is fixed and not adjusted if price inflation increases. So why are equity investors worried about higher inflation? Three reasons:

i) Central banks need to rethink their approach. The inflation outlook affects interest rate levels. Interest rate levels affect equity prices.

ii) Inflation changes create uncertainty among the participants in the economy, and the price scenario becomes more unclear. Some companies may raise their prices in line with inflation, while this is more difficult for others due to tough competition.

iii) High inflation often coincides with unstable inflation, which also creates uncertainty. This is part of the reason why central banks attempt to control inflation.

So, let's take a closer look at the price inflation in the US. Annual US price inflation from March to April leapt from 1.7 to 3 per cent. About half of this increase was expected, and easy to calculate. The rest of the increase came by surprise. It was the result of unexpected price rises for certain consumer price index components from March to April this year. In particular, there was a strong contribution from the used car market component.

We think this is due to some bottlenecks having been formed in this part of the economy over the course of the pandemic. Parts of the economy are stuck in the wrong gear in the transitional period while the economy is opening up. We must therefore be prepared for some rather unusual data, but we believe this to be temporary. The bottlenecks will disappear once the economy readjusts. The US central bank also emphasises that it views the rise in inflation as temporary, and it’s too early to draw a different conclusion. We are therefore not making any changes in our portfolios based on recent developments in price inflation, but will continue to monitor the situation.

Encouraging growth and earnings scenario
All companies have now reported their results for the first quarter of this year. The numbers are encouraging. Economic growth also continues to increase. In the US, the GDP has almost reached its pre-pandemic level. European GDP figures are still slightly lower than before the pandemic, but then again, the vaccination and reopening processes have taken longer on our side of the pond. If Europe follows the US example, we should therefore have a good period to look forward to, which will in turn benefit European companies and cyclical sectors.

We have previously forecasted a further rise in long-term interest rates. We’re sticking with this, while emphasising that the central banks will be patient and that we don’t anticipate a sudden interest rate hike any time soon. The stock market has so far ridden out the interest rate increase. But the result of it can be seen more clearly within the stock market. The financial and commodity-related sectors have had the most favourable development, whereas defensive sectors have done worse. We believe this development will continue.

Nordic high-yield bond
Nordic high-yield bonds had a good start to the year, with an increase of more than 5 per cent.  Current yield has gone down to about 5,5 per cent. However, we’re unlikely to end up with this return as some losses are bound to occur. Normal losses will nevertheless give a satisfactory margin compared with traditional Norwegian bonds that have a current yield of about 1.7 per cent.